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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
                         FOR THE TRANSITION PERIOD FROM

                       COMMISSION FILE NUMBER: 333-40907

                        TOWN SPORTS INTERNATIONAL, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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<S>                                            <C>

                   NEW YORK                                      13-2749906
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
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                               888 SEVENTH AVENUE
                            NEW YORK, NEW YORK 10106
                                 (212)-246-6700
               (ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER,
       INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days.  Yes [X] No [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]

     The aggregate market value of Common Stock held by non-affiliates of the
registrant: Not applicable

     As of March 9, 2001, there were 1,005,698 shares of Class A Common Stock of
the Company outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain exhibits filed with the Registrant's Registration Statements on
Form S-1 and Forms S-4 (File Nos. 333-61439, 333-40907 and 333-82607, as
amended) are incorporated by reference into Part III of this Report on Form
10-K.
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                               TABLE OF CONTENTS

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ITEM                                                               PAGE
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<C>  <S>                                                           <C>
                                PART I
 1.  Business....................................................    1
 2.  Properties..................................................    9
 3.  Legal Proceedings...........................................   12
 4.  Submission of Matters to a Vote of Security Holders.........   12
                               PART II
 5.  Market for Registrant's Common Stock and Related Shareholder
     Matters.....................................................   12
 6.  Selected Financial Data.....................................   13
 7.  Management's Discussion and Analysis of Financial Condition
     and Results of Operations...................................   16
7A.  Quantitative and Qualitative Disclosures About Market
     Risks.......................................................   23
 8.  Financial Statements and Supplementary Data.................   23
 9.  Changes in and Disagreements with Accountants on Accounting
     and Financial   Disclosure..................................   23
                               PART III
10.  Directors and Executive Officers of the Registrant..........   24
11.  Executive Compensation......................................   25
12.  Security Ownership of Certain Beneficial Owners and
     Management..................................................   27
13.  Certain Relationships and Related Transactions..............   28
                               PART IV
14.  Exhibits, Financial Statement Schedules, and Reports on Form
     8-K.........................................................   31
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                        TOWN SPORTS INTERNATIONAL, INC.

                                     PART I

ITEM 1.  BUSINESS

GENERAL

     Town Sports International, Inc. (collectively with its subsidiaries, the
"Company") is one of the two leading owners and operators of fitness clubs in
the Northeast and Mid-Atlantic regions of the United States. As of December 31,
2000, the Company owned and operated 103 fitness clubs and partly owned and
operated two fitness clubs. These 105 clubs collectively served approximately
278,000 members. The Company develops clusters of clubs to serve densely
populated major metropolitan regions in which a high percentage of the
population commutes to work. The Company services such populations by clustering
clubs near the highest concentrations of its target members' areas of both
employment and residence. The Company's target member is college-educated,
typically between the ages of 20 and 54 and earns an annual income in excess of
$50,000.

     The Company's goal is to develop the premier fitness club network in each
of the major metropolitan regions in which it operates. Management believes that
clustering clubs allows the Company to achieve strategic operating advantages
that enhance its ability to achieve this goal. When entering new regions, the
Company develops its clusters by initially opening or acquiring clubs located in
the more central urban markets of the region and then branching out from these
urban centers to suburbs and ancillary communities. Capitalizing on this
clustering of clubs, as of December 31, 2000, approximately 43.3% of the
Company's members participated in a membership plan that allows unlimited access
to all of the Company's clubs for a higher membership fee.

     The Company has executed this strategy successfully in the New York region
through the network of fitness clubs it operates under its New York Sports Club
("NYSC") brand name. The Company is the largest fitness club operator in
Manhattan with 30 locations and operates a total of 70 clubs under the NYSC name
within a defined radius of New York City. The Company operates 15 clubs in the
Boston region and 13 clubs in the Washington, DC region under its Boston Sports
Club ("BSC") and Washington Sports Club ("WSC") brand names respectively and has
begun establishing a similar cluster in the Philadelphia region under its
Philadelphia Sports Club ("PSC") brand name. The Company employs localized brand
names for its clubs to create an image and atmosphere consistent with the local
community and to foster recognition as a local network of quality fitness clubs
rather than a national chain.

     In July 2000, we purchased Health Development Corporation "HDC" for an
aggregate purchase price of $19.2 million, significantly, increasing our
presence in the greater Boston market. HDC operated nine fitness clubs and
provided management services at three fitness clubs in the greater Boston
market.

     In 1998, the Company changed its fiscal year end from May 31 to December
31, which resulted in a transition period of seven months ended December 31,
1998. The decision to change the fiscal year was made for more convenience in
both internal and external communications.

     The Company has experienced significant growth over the past several years
through a combination of (i) acquiring existing, privately owned, single and
multi-club businesses, and (ii) developing and opening "greenfield" club
locations. From June 1, 1995 to December 31, 2000, the Company acquired 50
existing clubs, opened 33 greenfield clubs, and relocated three clubs to
increase its total clubs under operation from 25 to 105. The Company has plans
to acquire or open 15 more clubs prior to December 31, 2001. The Company has
achieved revenue growth over the five year and seven month period ended December
31, 2000 at a compound annual rate of approximately 43.0% from $43.8 million for
the year ended May 31, 1996 to $225.0 million for the year ended December 31,
2000. This growth has been driven not only by the addition of acquired and
greenfield club locations, but also through mature club revenue growth, which
has ranged from 8.2% to 18.6% for the five year and seven month period ended
December 31, 2000 and was 18.6% for the year ended December 31, 2000. Mature
club (as defined in Selected Financial Data) revenue growth has enabled the
Company to increase revenue per weighted average club over the five year and
seven month period ended
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December 31, 2000. Revenue per weighted average club (as defined in Selected
Financial Data) has risen from $2.0 million for the year ended May 31, 1996 to
$2.4 million for the year ended December 31, 2000. Based on the Company's
historical experience, a new club tends to achieve significant increases in
revenues during its first three years of operation as it reaches maturity.
Because clubs experience little incremental cost associated with such revenue
increases, the Company realizes a greater proportionate increase in
profitability. This operating leverage has allowed it to achieve EBITDA (as
defined in Selected Financial Data) growth over the five year and seven month
period ended December 31, 2000 at a compound annual rate of approximately 64.4%
from $5.1 million for the year ended May 31, 1996 to $49.4 million for the year
ended December 31, 2000.

     The Company's model club ranges in size from approximately 15,000 to 25,000
square feet and averages approximately 21,000 square feet. Clubs typically have
an open space to accommodate cardiovascular and strength-training exercise, as
well as special purpose rooms to accommodate aerobic class instruction and other
exercise programs as well as massage. Locker rooms generally include a sauna and
steam room. Management seeks to provide a broad array of high quality exercise
programs and equipment that is both popular and effective, while reinforcing the
quality exercise experience the Company strives to make available to its
members. While the Company does not generally build locations with amenities
such as swimming pools or racquet and basketball courts, the Company does strive
to establish at least one flagship club that has such amenities in each of its
markets. Management believes that it is generally more economical to acquire
clubs with such amenities than to develop them as greenfield clubs.

     Management engages in a detailed site analysis and selection process based
upon information provided by the Company's proprietary development software to
identify potential target areas for additional clubs based upon population
demographics, traffic and commuting patterns, availability of sites and
competitive market information. In addition to the Company's existing 105 clubs
under operation and the 16 sites for which the Company has entered into lease
commitments, management has identified approximately 75 target areas in which it
may add clubs under the brand names NYSC, BSC, WSC, or PSC. Management estimates
that it will identify approximately 50 additional target areas in which it may
add clubs under these brand names. Once the Company begins to approach
saturation of these regions, management will explore expansion opportunities in
contiguous regions along the East Coast and the Mid-Atlantic.

     The Company possesses an experienced management team, the top five
executives of which have been working together at the Company since 1990.
Management believes that it has the depth, experience and motivation to manage
the Company's internal and external growth, and that the Company has put in
place the infrastructure and systems to manage effectively the Company's planned
expansion. Management believes that the presence of such infrastructure will
enable the Company over time to leverage certain fixed cost aspects of overhead
to realize increased EBITDA margins as the Company continues to expand its club
base. This operating leverage has already helped the Company to increase its
EBITDA margin by more than 125% to approximately 21.9% for the year ended
December 31, 2000 compared to approximately 9.7% in fiscal 1997.

INDUSTRY OVERVIEW

     According to published industry sources, total fitness club industry
revenues have increased at a compound annual rate of approximately 8.5% from
$6.5 billion in 1993 to $10.6 billion in 1999. Over the same period of time,
fitness club memberships have increased at a compound annual rate of 4.5% from
22.9 million to 29.9 million and have increased over 70% since 1987. These
statistics imply that average revenue per member has grown at a compound annual
rate of 4.0% for the industry since 1993. Industry revenue growth outpaced the
growth of fitness clubs, which has grown at a compound annual rate of 4.5% to
approximately 15,370 in 1999 from approximately 11,655 in 1993. Management
believes that fitness clubs, on average, have experienced significant excess
capacity historically. Only more recently has the industry as a whole
experienced the level of membership and revenue per club to realize the benefits
of the inherent operating leverage in the industry.

     Management believes that the growth in fitness club memberships is
attributable to several factors. Americans are focused on achieving a healthier,
more active lifestyle. Of the factors members consider very

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important in their decision to join a fitness club, the most commonly mentioned
is health, closely followed by appearance related factors including muscle tone,
looking better and weight control. Management believes that the increased
emphasis on appearance and wellness in the media has heightened the focus on
self image and fitness and will continue to do so. Management also believes that
fitness clubs provide a more convenient venue for exercise than outdoor
activities, particularly in densely populated metropolitan areas. According to
published industry reports, convenience is an important factor in choosing a
fitness club.

     According to industry sources, the five major trends that are driving
changes in the health and fitness industry include: (i) an influx of
institutional capital investment is leading a transformation of club ownership
from private to public; (ii) large operators are beginning to build regional and
national platforms to consolidate the industry and, in turn, are providing
liquidity for many small operators; (iii) the aging of the American population
is creating an awareness of and a need for healthy living and physical fitness;
(iv) insurers are beginning to partner with corporations to promote preventative
healthcare programs such as fitness clubs memberships, (v) Increases in non-dues
revenue is providing revenue diversification opportunities and improving
membership retention.

     In 1999, average monthly membership dues were $57 for a single adult.
Around this average monthly fee, management believes the industry can be
segregated into three tiers based upon price, service and quality: (i) an upper
tier consisting of clubs with monthly membership dues averaging in excess of
$80.00 per month; (ii) a middle tier consisting of clubs with monthly membership
dues averaging between $80.00 and $40.00 per month; and (ii) a lower tier
consisting of clubs with monthly membership dues averaging less than $40.00 per
month. The Company competes in the middle tier in terms of pricing and is
positioned toward the upper end of this tier. Based upon the quality and service
the Company provides its members, management believes that the Company provides
an attractive value to its members at the monthly membership dues it charges.

     The fitness club industry is highly fragmented. In 1999, the 20 largest
operators accounted for approxi-mately 20% of total club ownership. In addition,
approximately 65.0% of the total industry clubs are operated by single club
operators. Based upon this data, management believes that further consolidation
will occur in the industry.

MARKETING

     The Company's marketing campaign is directed by its in-house media
department which is headed by the Chief Operating Officer. This team develops
advertising strategies to convey each of the Company's regionally branded
networks as the premier network of fitness clubs in that region. Advertisements
are designed to highlight the consistent quality and high value-to-price ratio
management believes the Company provides through a combination of its membership
programs, club facilities and personnel. The media team's goal is to achieve
broad awareness of the Company's regional brand names primarily through radio,
television, newspaper, billboard, and direct mail advertising. Management
believes that the Company's clustering of clubs creates economies in its
marketing and advertising strategy that increase the efficiency and
effectiveness of these campaigns.

     Advertisements generally feature creative slogans that communicate the
serious approach the Company takes toward fitness in a provocative and/or
humorous tone, rather than pictures of the Company's clubs or members
exercising. Promotional marketing campaigns will typically feature opportunities
to participate in value-added services such as personal training for a limited
time at a discount to the standard rate. On occasion, the Company will also
offer reduced initiation fees to encourage enrollment. Additionally, the Company
frequently sponsors member referral incentive programs. At least 20% of the
Company's new members cite a referral from an existing member as a reason for
joining. Such incentive programs include a free month of membership, personal
training sessions, sports equipment such as a free gym bag or a gift certificate
for other in-club purchases. In addition, the Company maintains web sites that
provide information about club locations, program offerings and on-line
promotions.

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     The Company also engages in public relations and special events to promote
its image in the local communities. Management believes that these public
relations efforts enhance the Company's image and the image of its local brand
names in the communities in which it operates. The Company also seeks to build
its community image through co-operative advertising campaigns with local
sporting goods retailers.

     We maintain the following web site: www.mysportsclubs.com that provides
information about club locations, program offerings and on-line promotions.

SALES

     Sales of new memberships are generally handled at the club level. The
Company employs approximately 375 "in-club" membership consultants who are
responsible for new membership sales. Each club generally has two full-time and
one part-time membership consultants. These consultants report both to the
general manager of the club as well as to one of the Company's 14 area sales
managers, who in turn report to the Company's Vice President Sales. Membership
consultants' compensation consists of a base salary plus commission. Sales
commissions range from $45.00 to $65.00 per new member enrolled. The Company
provides additional incentive-based compensation in the form of bonuses
contingent upon individual, club and Company-wide enrollment goals. Membership
consultants must successfully complete a three-month, in-house training program
through which they learn the Company's sales strategy. In making a sales
presentation, membership consultants emphasize: (i) the proximity of its clubs
to concentrated commercial and residential areas convenient to where target
members live and work; (ii) the lack of a long-term obligation on the part of
the enrollee; (iii) the price value relationship of a Town Sports membership;
and (iv) access to value-added services. Management believes that providing
employees with opportunities for career advancement is essential to the
Company's ability to attract and retain qualified sales personnel. The Company
also employs full-time corporate sales managers whose responsibility is to
solicit group memberships through senior level corporate contacts.

     Management believes that clustering clubs allows the Company to sell
memberships based upon the opportunity for members to utilize multiple club
locations to differing degrees. The Company has streamlined its membership
structure to simplify the sales process. In addition, the proprietary
centralized computer software utilized by the Company ensures consistency of
pricing and controls enrollment processing at the club level. The Company offers
three principal types of memberships:

          The Passport Membership, priced from $67.00 to $85.00 per month, is
     the Company's highest priced membership and entitles members to use any
     Town Sports club at any time. This membership is held by approximately
     43.3% of members.

          The Gold Membership, priced from $44.00 to $77.00 per month based on
     the market area of enrollment, enables members to use a specific club, or a
     group of specific clubs, at any time and any Town Sports club during
     off-peak times. This membership is held by over 56.0% of members.

          The Off-peak Membership, priced from $44.00 to $70.00 per month, is
     the least expensive membership, and allows members to use any Town Sports
     club only during off-peak times. This membership is held by approximately
     0.7% of members.

     By clustering a group of clubs in a geographic area, the value of Company
memberships is enhanced by the ability to offer Passport Memberships, which
allow the member to use any Company club at any time. Management believes the
popularity of the Passport Membership results from the broader privileges and
greater convenience this membership plan provides through the opportunity for
members to access club facilities near to both their homes and offices. The
Company's clustering strategy also allows it to provide access to special
facilities and programs such as squash, tennis, basketball and racquetball
courts, swimming pools and programs targeted at children and other groups,
through flagship locations strategically located in key target areas without
offering such facilities or programs in every location.

     In joining a club, a new member signs a membership agreement which
obligates the member to pay a one-time initiation fee and monthly dues on an
ongoing basis. Monthly Electronic Funds Transfer "EFT" membership dues averaged
approximately $64.88 per month for the year ended December 31, 2000. During

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that same period, initiation fees averaged $99.30 for EFT members. The Company
collects approximately 89.3% of all monthly membership dues through EFT and EFT
revenue constitutes over 70% of consolidated revenue for the year ended December
31, 2000. Substantially all other monthly membership dues are paid in advance.
EFT members can generally cancel memberships at any time upon 30 days notice.
Based upon detailed statistical studies of the membership base at the Company's
mature clubs, however, the average length of the Company's memberships is
approximately 24 months. The membership agreement calls for monthly dues to be
collected by EFT based on credit card or bank account debit authorization
contained in the agreement. Management believes that its EFT program of monthly
dues collection provides a predictable and stable cash flow for the Company,
eliminates the traditional accounts receivable function, and minimizes bad-debt
write-offs while providing a significant competitive advantage in terms of the
sales process, dues collection, working capital management and membership
retention. In addition, it enables the Company to increase its dues in an
efficient and consistent manner. During the first week of each month, the
Company receives the EFT dues for that month by wire transfers initiated by a
third party EFT processor. Discrepancies and insufficient funds incidents are
researched and resolved by an in-house staff. For the year ended December 31,
2000, the Company experienced an average of uncollected EFT dues of less than
1.0%.

     The Company's total EFT revenue has increased by $11.3 million per month
from $3.5 million in December, 1996 to $14.8 million in December, 2000. While
the Company strongly encourages monthly EFT memberships, approximately 10.7% of
the Company's members (often corporate group members) purchase paid-in-full
memberships for a one year term. Annually the Company raises its monthly dues by
between 1% and 3%.

CLUB FORMAT AND LOCATIONS

     The Company's clubs are typically located in well-established,
higher-income residential, commercial or mixed urban neighborhoods within major
metropolitan areas which are capable of supporting the development of a cluster
of clubs. Fitness clubs generally have relatively high "retail" visibility, and
close proximity to transportation. In the New York City, Boston and Washington,
DC markets, the Company has created clusters of clubs in urban areas and their
commuter suburbs in accordance with the Company's operating strategy of offering
its target members the convenience of multiple locations close to where they
live and work, reciprocal use privileges and standardized facilities and
services. The Company has begun establishing a similar cluster in Philadelphia.

     Approximately half of the clubs operated by the Company are urban clubs
while half are suburban. The Company's urban clubs generally range in size from
15,000 to 25,000 square feet and averages approximately 21,000 square feet. The
Company's suburban clubs vary in size from 15,000 square feet to 75,000 square
feet with one club being 200,000 square feet. Excluding this single large club
the average suburban club is 24,000 square feet. Membership for each club
generally ranges from 2,500 to 5,500 members at maturity. Although club members
represent a cross-section of the population in a given geographic market, the
Company's typical member is college educated, between the ages of 20 and 54 and
earns an annual income of $50,000.

     The Company's facilities include state-of-the-art cardiovascular equipment,
including Lifecycles, StairMasters, treadmills, and elliptical motion machines;
strength equipment and free weights, including Cybex, Icarian, Nautilus, Ground
Zero, and Hammer Strength equipment; group exercise and cycling studio(s);
E-Zone and Cardio-Theater entertainment systems; locker rooms, including shower
facilities, towel service, and other amenities such as massage, saunas and
steamrooms; babysitting, and a retail shop. Personal training services are
offered at all locations and massage is offered at most clubs, each at an
additional charge. At certain flagship locations, additional facilities also are
offered, including swimming pools, basketball, tennis, racquetball and/or squash
courts and climbing walls. Also, the Company is significantly expanding the
availability of fee-based programming at many of its clubs, including programs
targeted at children and other groups.

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CLUB OPERATIONS

     The Company emphasizes consistency and quality in all of its club
operations, including:

          Management.  The Company believes that its success is largely
     dependent on the selection and training of its staff and management. The
     Company's management structure is designed, therefore, to support the
     professional development of highly motivated managers who will execute the
     Company's directives and support growth.

          Corporate departments are responsible for each area of club services,
     such as exercise group programs, fitness programming, personal training,
     facility and equipment maintenance, housekeeping and laundry. This
     centralization allows local general managers at each club to focus on
     customer service, club staffing and providing a high quality exercise
     experience. General managers are responsible for the day-to-day management
     of each club, and directly report to regional managers, who liaise with
     corporate staff ensuring consistent service at all locations.

          The Company provides performance-based incentives to its management.
     Senior management compensation, for example, is tied to overall Company
     performance. Departmental directors, area managers and general managers
     have bonuses tied to financial and member retention targets for a
     particular club or group of clubs. The Company offers its employees various
     benefits including; health, dental, disability, insurance and a 401(k)
     plan. Management believes the availability of employee benefits provides
     the Company a strategic advantage in attracting and retaining quality
     program instructors and professional personal trainers and that this
     strategic advantage in turn translates into a more consistent and higher
     quality workout experience for those members who utilize such services.

          Personal Training.  All of the Company's fitness clubs offer
     one-on-one personal training, which is sold by the single session or in
     multi-session packages. The Company has implemented a comprehensive staff
     education curriculum which progresses from basic knowledge and practical
     skills to advanced concepts and training techniques. The Company's
     education program provides professional standards to ensure that its
     trainers provide superior service and fitness expertise to its members.
     There are four levels of professional competency with mandatory
     requirements trainers must meet in order to achieve and maintain such
     status: Fitness Trainer (completed in-house certification programs),
     Certified Fitness Trainer (completed in-house certification and holds
     approved nationally recognized certification). Pro Trainer (has completed
     all previous requirements, passed the Company's Advanced Training Systems
     and holds a degree or nationally-recognized certification), Master Trainer
     (has met all requirements of a Pro Trainer, and holds multiple degrees and
     certifications, including at least one specialty or advanced
     certification). Management believes the qualifications of the personal
     training staff helps ensure that members receive a consistent level of
     quality service throughout the Company's club base. The Company believes
     that its personal training programs provide valuable guidance to its
     members and a significant source of incremental revenue from value-added
     services for the Company. In addition management believes that members who
     participate in personal training programs, have a longer membership life.

          Group Fitness.  The Company's commitment to providing a quality
     workout experience to its members extends to the employment of program
     instructors, who teach aerobics, cycling, strength conditioning, boxing,
     yoga and step aerobics classes, among others. The Company's clustering
     strategy enables it to staff program instructors and professional personal
     trainers at more than one club. As a result, the Company can vary a given
     club's instructors, while providing instructors sufficient classes to
     effectively and economically treat these instructors as full-time
     employees. All program instructors report to a centralized management
     structure, headed by the Director of Programming who is responsible for
     overseeing auditions and providing in-house training to keep instructors
     current in the latest training techniques and program offerings.

          Sports Clubs for Kids.  During 2000, the Company began offering
     programs for children under the Sports Club for Kids brand at eight
     locations in the NYSC and PSC regions. In addition to extending fitness
     offerings to a market not previously served by the Company, it is expected
     that Sports Clubs for Kids programming will help position the Company's
     suburban clubs as family clubs, which should

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     provide it with significant competitive advantage. Depending upon the
     facilities available at a location, Sports Clubs for Kids programming can
     include traditional youth offerings such as day camps, sports camps, swim
     lessons, hockey and soccer leagues, gymnastics, dance, martial arts and
     birthday parties. It also can include innovative and proprietary
     programming such as Kidspin Theater, a multi-media cycling experience, and
     non-competitive "learn-to-play" sports programs. The Company expects to be
     operating Sports Clubs for Kids programs in more than 20 of its facilities
     by the end of 2001.

PROPRIETARY CENTRALIZED INFORMATION SYSTEMS

     The Company has developed a proprietary system to track and analyze sales,
leads, and membership statistics which, in conjunction with its other systems,
allows the Company to track the frequency of member workouts, multi-club
utilization, value-added services and demographic profiles by member, which
enables the Company to develop targeted direct marketing programs and to modify
its broadcast and print advertising to improve consumer response. These systems
also assist the Company in evaluating staffing needs and program offerings. In
addition, the Company relies on certain data gathered through its information
systems to assist in the identification of new markets for clubs and site
selection within those markets.

PLANNED INFORMATION SYSTEMS DEVELOPMENTS

     The Company recognizes the value of enhancing and extending the uses of
information technology in virtually every area of the company. After developing
an information technology strategy to support the business strategy, the Company
has developed a comprehensive two-year plan to replace or upgrade key systems.

     The Company expects to begin implementation of a new fully integrated club
management system in the later part of 2001. This system incorporates
contemporary browser-based technology and open architecture to provide ease of
integration with other systems and scalability to support the Company's
projected growth. This system will provide enhanced or new functionality for
member services, contract management, billing, point of sale, inventory control,
scheduling, and reservations.

     The Company completed development of the first phase of an enhanced website
in 2000. With the implementation of the above mentioned club management system,
the Company will expand its website to incorporate other e-business
functionality such as sales of products, services, and memberships,
reservationing, and tracking of personal fitness programs.

     Additionally, in 2001 the Company will implement a new system for flexible
financial reporting, budgeting, forecasting, and analysis of business
information from multiple source systems to enhance the management
decision-making processes and to improve controls.

INTELLECTUAL PROPERTY

     The Company has registered, and is in the process of registering, various
trademarks and service marks with the U.S. Patent and Trademark Office,
including NEW YORK SPORTS CLUBS, WASHINGTON SPORTS CLUBS, BOSTON SPORTS CLUBS,
PHILADELPHIA SPORTS CLUBS, TSI and TOWN SPORTS INTERNATIONAL, INC.

COMPETITION

     The fitness club industry is highly competitive. The Company competes with
other fitness clubs, physical fitness and recreational facilities established by
local governments and hospitals and by businesses for their employees, amenity
and condominium clubs, the YMCA and similar organizations and, to a certain
extent, with racquet and tennis and other athletic clubs, country clubs, weight
reducing salons and the home-use fitness equipment industry. The Company also
competes with other entertainment and retail businesses for the discretionary
income of its target markets. There can be no assurance that the Company will be
able to compete effectively in the future in the markets in which it operates.
Competitors, which may include companies which are larger and have greater
resources than the Company, may enter these markets to the detriment of the
Company. These competitive conditions may limit the Company's ability to
increase dues

                                        7
<PAGE>   10

without a material loss in membership, attract new members and attract and
retain qualified personnel. Additionally, consolidation in the fitness club
industry could result in increased competition among participants, particularly
large multi-facility operators that are able to compete for attractive
acquisition candidates, thereby increasing costs associated with expansion
through both acquisitions, and lease negotiation and real estate availability
for greenfields.

     Management believes that its market leadership, experience and operating
efficiencies enable it to provide the consumer with a superior product in terms
of convenience, quality and affordability. Management believes that there are
significant barriers to entry in its urban markets, including restrictive zoning
laws, lengthy permit processes and a shortage of appropriate real estate, which
could discourage any large competitor from attempting to open a chain of clubs
in these markets. However, such a competitor could enter these markets more
easily through one or a series of acquisitions.

EMPLOYEES

     At December 31, 2000, the Company had approximately 6,400 employees, of
which approximately 2,275 were employed full-time. Approximately 300 employees
were corporate personnel working in the Manhattan, Boston or Washington, DC
offices. The Company is not a party to any collective bargaining agreement with
its employees. The Company has never experienced any significant labor shortages
nor had any difficulty in obtaining adequate replacements for departing
employees and considers its relations with its employees to be good. Management
believes that it offers its employees benefits (including health, dental,
disability insurance and a 401(k) plan) which are superior to those generally
offered by its competitors.

GOVERNMENT REGULATION

     The operations and business practices of the Company are subject to
regulation at the federal, state and, in some cases, local levels. State and
local consumer protection laws and regulations govern the Company's advertising,
sales and other trade practices.

     Statutes and regulations affecting the fitness industry have been enacted
in states in which the Company conducts business; many other states into which
the Company may expand have adopted or likely will adopt similar legislation.
Typically, these statutes and regulations prescribe certain forms and provisions
of membership contracts, afford members the right to cancel the contract within
a specified time period after signing, require an escrow of funds received from
pre-opening sales or the posting of a bond or proof of financial responsibility,
and may establish maximum prices for membership contracts and limitations on the
term of contracts. In addition, the Company is subject to numerous other types
of federal and state regulations governing the sale of memberships. These laws
and regulations are subject to varying interpretations by a number of state and
federal enforcement agencies and the courts. The Company maintains internal
review procedures in order to comply with these requirements, and believes that
its activities are in substantial compliance with all applicable statutes, rules
and decisions.

     Under so-called state "cooling-off" statutes, a member has the right to
cancel his or her membership for a period of three to ten days (depending on the
applicable state law) and, in such event, is entitled to a refund of any
initiation fee paid. In addition, the Company's membership contracts provide
that a member may cancel his or her membership at any time for medical reasons
or relocation a certain distance from the nearest club. The specific procedures
for cancellation in these circumstances vary due to differing state laws. In
each instance, the canceling member is entitled to a refund of prepaid amounts
only. Furthermore, where permitted by law, a cancellation fee is due to the
Company upon cancellation and the Company may offset such amount against any
refunds owed.

                                        8
<PAGE>   11

                           FORWARD-LOOKING STATEMENTS

     Certain statements in this Annual Report on Form 10-K of the Company for
the year ended December 31, 2000 are forward-looking statements, including,
without limitation, statements regarding future financial results and
performance, potential sales revenue and tax benefits. These statements are
subject to various risks and uncertainties, many of which are outside the
control of the Company, including the level of market demand for the Company's
services, competitive pressures, the ability to achieve reductions in operating
costs and to continue to integrate acquisitions, environmental matters, the
application of Federal and state tax laws and regulations, and other specific
factors discussed herein and in other Securities and Exchange Commission filings
by the Company. The information contained herein represents management's best
judgement as of the date hereof based on information currently available;
however, the Company does not intend to update this information to reflect
development or information obtained after the date hereof and disclaims any
legal obligation to the contrary.

ITEM 2.  PROPERTIES

<TABLE>
<CAPTION>
                                                                                DATE OPENED OR
                                                                                  MANAGEMENT
LOCATION                                   ADDRESS                                  ASSUMED
--------                                   -------                              --------------
<S>  <C>                                   <C>                                  <C>
NEW YORK SPORTS CLUBS:
1.   Manhattan...........................  151 East 86th Street                 January, 1977
2.   Manhattan...........................  61 West 62nd Street                  July, 1983
3.   Manhattan...........................  614 Second Avenue                    July, 1986
4.   Manhattan...........................  380 Madison Avenue                   January, 1990
5.   Manhattan...........................  151 Reade Street                     January, 1990
6.   Manhattan...........................  1601 Broadway                        September, 1991
7.   Manhattan...........................  50 West 34th Street                  August, 1992
8.   Manhattan...........................  349 East 76th Street                 April, 1994
9.   Manhattan...........................  248 West 80th Street                 May, 1994
10.  Manhattan...........................  502 Park Avenue                      February, 1995
11.  Manhattan...........................  117 Seventh Avenue South             March, 1995
12.  Manhattan...........................  303 Park Avenue South                December, 1995
13.  Manhattan...........................  30 Wall Street                       May, 1996
14.  Manhattan...........................  1635 Third Avenue                    October, 1996
15.  Manhattan...........................  575 Lexington Avenue                 November, 1996
16.  Manhattan...........................  278 Eighth Avenue                    December, 1996
17.  Manhattan...........................  200 Madison Avenue                   February, 1997
18.  Manhattan...........................  131 East 31st Street                 February, 1997
19.  Manhattan...........................  2162 Broadway                        November, 1997
20.  Manhattan...........................  633 Third Avenue                     April, 1998
21.  Manhattan...........................  1657 Broadway                        July, 1998
22.  Manhattan...........................  217 Broadway                         March, 1999
23.  Manhattan...........................  23 West 73rd Street                  April, 1999
24.  Manhattan...........................  34 West 14th Street                  July, 1999
25.  Manhattan...........................  503-511 Broadway                     July, 1999
26.  Manhattan...........................  1372 Broadway                        October, 1999
27.  Manhattan...........................  300 West 125th Street                May, 2000
28.  Manhattan...........................  Battery Park City                    May, 2000
29.  Manhattan...........................  14 West 44th Street                  August, 2000
30.  Manhattan...........................  128 Eighth Avenue                    December, 2000
31.  Manhattan+..........................  19 Irving Place                      Opening 2001
</TABLE>

                                        9
<PAGE>   12

<TABLE>
<CAPTION>
                                                                                DATE OPENED OR
                                                                                  MANAGEMENT
LOCATION                                   ADDRESS                                  ASSUMED
--------                                   -------                              --------------
<S>  <C>                                   <C>                                  <C>
32.  Manhattan+..........................  160 Water Street                     Opening 2001
33.  Brooklyn, NY........................  110 Boerum Place                     October, 1985
34.  Brooklyn, NY........................  1736 Shore Parkway                   June, 1998
35.  Brooklyn, NY+.......................  179 Remsen Street                    Opening 2001
36.  Brooklyn, NY*.......................  453 Fifth Avenue                     Opening 2003
37.  Queens, NY..........................  69-33 Austin Street, Forest Hills    April, 1997
38.  Queens, NY..........................  153-67 A Cross Island Parkway        June, 1998
39.  Staten Island, NY...................  300 West Service Road                June, 1998
40.  Scarsdale, NY.......................  696 White Plains Road                October, 1995
41.  Mamaroneck, NY......................  124 Palmer Avenue                    January, 1997
42.  White Plains, NY....................  1 North Broadway                     September, 1997
43.  Croton-on-Hudson, NY................  420 South Riverside Drive            January, 1998
44.  Larchmont, NY.......................  15 Madison Avenue                    December, 1998
45.  Nanuet, NY..........................  58 Demarest Mill Road                May, 1998
46.  Great Neck, NY......................  15 Barstow Road                      July, 1989
47.  East Meadow, NY.....................  625 Merrick Avenue                   January, 1999
48.  Commack, NY.........................  6136 Jericho Turnpike                January, 1999
49.  Oceanside, NY.......................  2909 Lincoln Avenue                  May, 1999
50.  Long Beach, NY......................  265 East Park Avenue                 July, 1999
51.  Garden City, NY.....................  833 Franklin Avenue                  May, 2000
52.  Huntington, NY......................  350 New York Avenue                  February, 2001
53.  Syosset, NY+........................  49 Ira Road                          Opening 2001
54.  Woodmere, NY*.......................  158 Irving Street                    Opening 2002
55.  Stamford, CT........................  6 Landmark Square                    December, 1997
56.  Stamford, CT........................  106 Commerce Road                    January, 1998
57.  Danbury, CT.........................  38 Mill Plain Road                   January, 1998
58.  Stamford, CT........................  1063 Hope Street                     November, 1998
59.  Norwalk, CT.........................  250 Westport Avenue                  March, 1999
60.  Greenwich, CT.......................  6 Liberty Way                        May, 1999
61.  East Brunswick, NJ..................  8 Cornwall Court                     January, 1990
62.  Princeton, NJ.......................  301 North Harrison Street            May, 1997
63.  Freehold, NJ........................  200 Daniels Way                      April, 1998
64.  Matawan, NJ.........................  163 Route 34                         April, 1998
65.  Old Bridge, NJ......................  Gaub Road and Route 516              April, 1998
66.  Marlboro, NJ........................  34 Route 9 North                     April, 1998
67.  Fort Lee, NJ........................  1355 15th Street                     June, 1998
68.  Ramsey, NJ..........................  1100 Route 17 North                  June, 1998
69.  Mahwah, NJ..........................  7 Leighton Place                     June, 1998
70.  Parsippany, NJ......................  2651 Route 10                        August, 1998
71.  Springfield, NJ.....................  215 Morris Avenue                    August, 1998
72.  Colonia, NJ.........................  1250 Route 27                        August, 1998
73.  Franklin Park, NJ...................  3911 Route 27                        August, 1998
74.  Plainsboro, NJ......................  10 Schalks Crossing                  August, 1998
75.  Somerset, NJ........................  120 Cedar Grove Lane                 August, 1998
76.  Hoboken, NJ.........................  221 Washington Street                October, 1998
77.  West Caldwell, NJ...................  913 Bloomfield Avenue                April, 1999
</TABLE>

                                        10
<PAGE>   13

<TABLE>
<CAPTION>
                                                                                DATE OPENED OR
                                                                                  MANAGEMENT
LOCATION                                   ADDRESS                                  ASSUMED
--------                                   -------                              --------------
<S>  <C>                                   <C>                                  <C>
78.  Montclair, NJ*......................  56 Church Street                     Opening 2002
WASHINGTON SPORTS CLUBS:
79.  Washington, DC......................  214 D Street, S.E.                   January, 1980
80.  Washington, DC......................  1835 Connecticut Avenue, N.W.        January, 1990
81.  Washington, DC......................  1990 M Street, N.W.                  February, 1993
82.  Washington, DC......................  2251 Wisconsin Avenue, N.W.          May, 1994
83.  Washington, DC......................  1211 Connecticut Avenue              July, 2000
84.  Bethesda, MD........................  4903 Elm Street                      May, 1994
85.  North Bethesda, MD..................  10400 Old Georgetown Road            June, 1998
86.  Germantown, MD......................  12623 Wisteria Drive                 July, 1998
87.  Silver Spring, MD*..................  Wayne Avenue                         Opening 2002
88.  Centreville, VA.....................  Old Centreville Crossing             December, 1997
89.  Alexandria, VA......................  3654 King Street                     June, 1999
90.  Sterling, VA........................  21800 Town Center Plaza              October, 1999
91.  Fairfax, VA.........................  11001 Lee Highway                    October, 1999
92.  West Springfield, VA................  8430 Old Keene Mill                  September, 2000
93.  Clarendon, VA*......................  2700 Clarendon Boulevard             Opening 2001
BOSTON SPORTS CLUBS:
94.  Boston, MA..........................  561 Boylston Street                  November, 1991
95.  Allston, MA.........................  15 Gorham Street                     July, 1997
96.  Boston, MA..........................  1 Bulfinch Place                     August, 1998
97.  Natick, MA..........................  Sherwood Plaza, 124 Worcester Rd     September, 1998
98.  Weymouth, MA........................  553 Washington Street                May, 1999
99.  Boston, MA..........................  201 Brookline Avenue                 June, 2000
100. East Cambridge, MA..................  6 Museum Way                         January, 2001
101. Wellesley, MA.......................  140 Great Plain Avenue               July, 2000
102. Boston, MA..........................  One Devonshire Place                 July, 2000
103. Andover, MA.........................  307 Lowell Street                    July, 2000
104. Lynnfield, MA.......................  425 Walnut Street                    July, 2000
105. Lexington, MA.......................  475 Bedford Avenue                   July, 2000
106. Franklin, MA........................  750 Union Street                     July, 2000
107. Framingham, MA......................  1657 Worcester Street                July, 2000
108. Danvers, MA.........................  50 Ferncroft Road                    July, 2000
109. Cambridge, MA+......................  625 Massachusetts Avenue             Opening 2001
110. Boston, MA+.........................  361 Newbury Street                   Opening 2001
111. West Newton, MA*....................  1359 Washington Street               Opening 2001
112. Nashua, NH..........................  11 Tara Boulevard                    July, 2000
PHILADELPHIA SPORTS CLUBS:
113. Philadelphia, PA....................  220 South 5th Street                 January, 1999
114. Philadelphia, PA....................  2000 Hamilton Street                 July, 1999
115. Chalfont, PA........................  One Highpoint Drive                  January, 2000
116. Cherry Hill, NJ.....................  Route 70 and Kings Highway           April, 2000
117. Philadelphia, PA....................  1735 Market Street                   October 2000
118. Bryn Mawr, PA*......................  822 Lancaster Avenue                 Opening 2001
119. Philadelphia, PA*...................  Rittenhouse Square                   Opening 2003
</TABLE>

                                        11
<PAGE>   14

<TABLE>
<CAPTION>
                                                                                DATE OPENED OR
                                                                                  MANAGEMENT
LOCATION                                   ADDRESS                                  ASSUMED
--------                                   -------                              --------------
<S>  <C>                                   <C>                                  <C>
SWISS SPORTS CLUBS:
120. Basel, Switzerland..................  St. Johanns-Vorstadt 41              August, 1987
121. Zurich, Switzerland.................  Glarnischstrasse 35                  August, 1987
122. Basel, Switzerland+.................  Basel FC Soccer Stadium              Opening 2001
</TABLE>

---------------
+ Under construction, club in "pre-sales."

* Signed leases for greenfield club development.

     The Company owns the 151 East 86th Street location, which houses a Company
fitness club and a retail tenant that generated approximately $540,000 of rental
income for the Company during twelve months ended December 31, 2000. One of our
fitness clubs operates under a month to month lease; all other fitness clubs
occupy leased space pursuant to long-term leases (generally 15 to 25 years,
including options). In the next five years (ending December 31, 2005), only one
of the Company's fitness club leases will expire without any renewal option. A
new club has been constructed and opened nearby.

     The Company leases approximately 40,000 square feet of office space in New
York City, and has smaller regional offices in Fairfax, VA, East Brunswick, NJ,
Stamford, CT and Waltham, MA, for administrative, and general corporate
purposes. The Company also leases warehouse and commercial space in Long Island
City, New York, for storage purposes and for the operation of a centralized
laundry facility for certain New York fitness clubs.

     As of December 31, 2000, 103 of the existing fitness clubs were wholly
owned by the Company and two were managed and partly owned (the "Partly Owned
Clubs").

     In addition, the Company provided management services at three fitness
clubs in which the Company had no equity interest.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is a party to various lawsuits arising in the normal course of
business. Management believes that the ultimate outcome of these matters will
not have a material adverse effect on the Company's business, results of
operations, cash flows, or financial condition.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

     Not applicable

                                        12
<PAGE>   15

ITEM 6.  SELECTED FINANCIAL DATA

                SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
                (IN THOUSANDS, EXCEPT CLUB AND MEMBERSHIP DATA)

     Set forth below are selected historical consolidated financial, other
operating data and club and membership data of the Company as of the dates and
for the periods presented. The selected historical consolidated statement of
operations data for the year ended May 31, 1998, the seven months ended December
31, 1998 and the years ended December 31, 1999 and 2000, and the selected
historical consolidated balance sheet data as of December 31, 1999 and 2000,
were derived from the audited Consolidated Financial Statements of the Company,
which are included herein. The selected historical consolidated statement of
operations data for the seven months ended December 31, 1997, were derived from
the unaudited consolidated financial statements of the Company which are
included herein. The selected historical consolidated statement of operations
data for the year ended May 31, 1996 and 1997 and the selected historical
consolidated balance sheet data as of May 31, 1996, 1997 and 1998 and December
31, 1998 were derived from the audited consolidated financial statements of the
Company, which are not included herein. In 1998, the Company changed its fiscal
year end from May 31 to December 31, which resulted in a transition period of
seven months ended December 31, 1998. The decision to change the fiscal year was
made for more convenience in both internal and external communications. The
information contained in this table and accompanying notes should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and
accompanying notes thereto appearing elsewhere herein.

<TABLE>
<CAPTION>
                                                                      YEAR ENDED MAY 31,
                                                                -------------------------------
                                                                 1996        1997        1998
                                                                -------    --------    --------
<S>                                                             <C>        <C>         <C>
STATEMENT OF OPERATIONS DATA:
Revenues....................................................    $43,755    $ 56,567    $ 82,350
Operating expenses:
  Payroll and related.......................................     18,626      23,321      33,309
  Club operating............................................     14,542      18,044      25,858
  General and administrative................................      3,562       3,774       5,825
  Depreciation and amortization.............................      2,929       4,219       7,736
  Compensation expense incurred in connection with stock
    options(1)..............................................      1,967       5,933       1,442
                                                                -------    --------    --------
Operating income............................................      2,129       1,276       8,180
Interest expense, net of interest income....................        952       2,455       5,902
                                                                -------    --------    --------
Income (loss) before provision (benefit) for income tax.....      1,177      (1,179)      2,278
Provision (benefit) for income tax..........................        628        (243)      1,131
Extraordinary item(2).......................................         --          --        (782)
Cumulative effect of change in accounting policy(3).........         --          --         (88)
                                                                -------    --------    --------
Net income (loss)...........................................        549        (936)        277
Accreted dividends on preferred stock.......................       (400)     (1,286)     (2,387)
                                                                -------    --------    --------
Net Income (loss) attributable to common stockholders.......    $   149    $ (2,222)   $ (2,110)
                                                                =======    ========    ========
OTHER DATA:
EBITDA(4)...................................................    $ 5,058    $  5,495    $ 15,916
EBITDA margin(4)............................................       11.6%        9.7%       19.3%
Deferred lease expense......................................    $ 1,277    $  1,620    $  2,671
Cash provided by (used in):
  Operating activities......................................      5,695      12,302      15,733
  Investing activities......................................     (5,487)    (13,571)    (36,040)
  Financing activities......................................    $   144    $  2,809    $ 40,836
</TABLE>

                                        13
<PAGE>   16

<TABLE>
<CAPTION>
                                                                      YEAR ENDED MAY 31,
                                                                -------------------------------
                                                                 1996        1997        1998
                                                                -------    --------    --------
<S>                                                             <C>        <C>         <C>
CLUB AND MEMBERSHIP DATA:
New clubs opened(5).........................................          2           3           1
Clubs acquired(5)...........................................          1           5          13
Wholly owned clubs operated at end of period(5).............         23          28          45
Total clubs operated at end of period(6)....................         28          35          49
Members at end of period(7).................................     54,800      78,600     125,100
Mature club revenue increase(8).............................        8.2%        9.9%       12.6%
Revenue per weighted average club (in thousands)(9).........    $ 2,017    $  2,267    $  2,287
</TABLE>

<TABLE>
<CAPTION>
                                           SEVEN MONTHS                   YEAR ENDED
                                        ENDED DECEMBER 31,               DECEMBER 31,
                                       --------------------    --------------------------------
                                         1997        1998        1998        1999        2000
                                       --------    --------    --------    --------    --------
<S>                                    <C>         <C>         <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
Revenues.............................  $ 42,990    $ 71,662    $111,022    $159,779    $225,049
Operating expenses:
  Payroll and related................    17,621      28,001      43,689      62,412      89,677
  Club operating.....................    13,258      24,261      36,861      52,619      69,390
  General and administrative.........     2,742       5,828       8,911      10,908      14,754
  Depreciation and amortization......     3,944       8,818      12,610      20,935      26,642
  Compensation expense incurred in
     connection with stock
     options(1)......................       397         434       1,479       2,042       1,836
                                       --------    --------    --------    --------    --------
Operating income.....................     5,028       4,320       7,472      10,863      22,750
Interest expense, net of interest
  income.............................     3,270       5,279       7,911      10,243      13,120
                                       --------    --------    --------    --------    --------
Income (loss) before provision
  (benefit) for income tax...........     1,758        (959)       (439)        620       9,630
Provision (benefit) for income tax...       888        (399)       (156)        571       4,799
Extraordinary item(2)................      (782)         --          --          --          --
Cumulative effect of change in
  accounting policy(3)...............       (88)         --          --          --          --
                                       --------    --------    --------    --------    --------
Net income (loss)....................        --        (560)       (283)         49       4,831
Accreted dividends on preferred
  stock..............................    (1,485)     (2,146)     (3,048)     (7,880)     (9,016)
                                       --------    --------    --------    --------    --------
Net loss attributable to common
  stockholders.......................  $ (1,485)   $ (2,706)   $ (3,331)   $ (7,831)   $ (4,185)
                                       ========    ========    ========    ========    ========
OTHER DATA:
EBITDA(4)............................  $  8,972    $ 13,138    $ 20,082    $ 31,798    $ 49,392
EBITDA margin(4).....................      20.9%       18.3%       18.1%       19.9%       21.9%
Non-cash rental lease expense, net of
  non-cash income....................  $  1,354    $  1,493    $  2,809    $  3,061    $  2,976
Cash provided by (used in):
  Operating activities...............     7,193       7,393      15,933      29,496      40,573
  Investing activities...............   (12,362)    (47,352)    (71,030)    (55,078)    (70,048)
  Financing activities...............  $ 42,361    $ 36,116    $ 34,591    $ 33,553    $  5,715
</TABLE>

                                        14
<PAGE>   17

<TABLE>
<CAPTION>
                                           SEVEN MONTHS                   YEAR ENDED
                                        ENDED DECEMBER 31,               DECEMBER 31,
                                       --------------------    --------------------------------
                                         1997        1998        1998        1999        2000
                                       --------    --------    --------    --------    --------
<S>                                    <C>         <C>         <C>         <C>         <C>
CLUB AND MEMBERSHIP DATA:
New clubs opened(5)..................        --           4           5          14           9
Clubs acquired(5)....................         5          16          25           4          11
Wholly owned clubs operated at end of
  period(5)..........................        35          65          65          82         103
Total clubs operated at end of
  period(6)..........................        40          69          69          86         105
Members at end of period(7)..........    99,900     178,700     178,700     203,059     278,000
Mature club revenue increase(8)......      12.6%       16.8%       14.2%       16.0%       18.6%
Revenue per weighted average club
  (in thousands)(9)..................  $  1,289    $  1,184    $  2,156    $  2,130    $  2,428
</TABLE>

<TABLE>
<CAPTION>
                                    AS OF MAY 31,                      AS OF DECEMBER 31,
                             ----------------------------   -----------------------------------------
                              1996      1997       1998       1997       1998       1999       2000
                             -------   -------   --------   --------   --------   --------   --------
<S>                          <C>       <C>       <C>        <C>        <C>        <C>        <C>
BALANCE SHEET DATA:
Working capital
  (deficit)................  $(4,048)  $(8,436)  $  5,898   $ 26,772   $    478   $ (1,015)  $(38,414)
Total assets...............   34,805    52,923    111,977    104,948    157,416    215,678    256,085
Long-term debt, including
  current installments.....   10,453    41,071     88,289     89,368     89,524    132,202    144,498
Redeemable senior preferred
  stock....................       --        --         --         --     36,735     42,066     48,029
Stockholders' equity
  (accumulated deficit)....  $ 5,474   $(6,951)  $ (5,107)  $ (6,342)  $ (2,333)  $ (5,597)  $ (3,911)
</TABLE>

---------------
(1) Represents non-cash charges related to the vesting of certain stock options
    issued to management and the accretion of preferred dividends related to
    preferred stock underlying certain of such options.

(2) Reflects the write-off of previously capitalized fees and expenses, net of
    taxes, of $782,000, related to the repayment of certain indebtedness.

(3) Prior to fiscal 1998, the Company capitalized direct costs incurred to
    obtain leases for new clubs to be constructed by the Company. During the
    quarter ended May 31, 1998, the Company adopted the provisions of Statement
    of Position 98-5 Reporting on the Costs of Start-up Activities ("SOP 98-5")
    which requires that these costs be expensed as incurred. In connection with
    the adoption of SOP 98-5 the Company, effective June 1, 1997, recorded a
    pre-tax charge of $88,000 net of $70,000 in taxes, as the cumulative effect
    of this accounting change.

(4) EBITDA is defined as earnings before interest, taxes, depreciation,
    amortization, extraordinary charges and cumulative effect of changes in
    accounting policy. EBITDA is presented because management believes it
    provides useful information regarding the operating performance and
    financial condition of the Company. EBITDA should not be considered in
    isolation or as a substitute for net income, cash flows, or other
    consolidated income (loss) or cash flow data prepared in accordance with
    GAAP or as a measure of the Company's profitability or liquidity. EBITDA
    Margin is defined as EBITDA as a percentage of revenues. Additionally,
    investors should be aware that EBITDA may not be comparable to similarly
    titled measures presented by other companies.

(5) During fiscal 1997, the Company opened or acquired six clubs and relocated
    one club upon the expiration of its lease. During fiscal 1998, the Company
    opened or acquired 14 clubs and acquired three formerly partly owned clubs.
    During calendar 1998, the Company acquired one formerly partly owned club.
    During 1999 the company relocated one club. During 2000 the Company acquired
    two formerly partly owned clubs and relocated one club upon the expiration
    of its lease.

(6) Includes wholly-owned or partly owned and managed clubs.

(7) Represents members at wholly-owned or partly owned clubs.

                                        15
<PAGE>   18

(8) The Company defines mature clubs as those clubs operated by the Company for
    more than 24 months.

(9) Revenue per weighted average club is calculated as club revenue divided by
    the product of the total numbers of clubs and their weighted average months
    in operation as a percentage of the total year or the seven months ended, as
    applicable.

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CHANGE OF FINANCIAL REPORTING PERIOD

     In 1998 the Company changed its fiscal year end from May 31 to December 31,
which resulted in a transition period of seven months ended December 31, 1998.
The decision to change the fiscal year was made for more convenience in both
internal and external communications. To aid comparative analysis, the Company
has elected to present the results of operations for the years ended December
31, 1999 and December 31, 1998, unaudited and the seven month periods ended
December 31, 1998, and December 31, 1997, unaudited, along with the previously
reported results of operations for the years ended May 31, 1998, and May 31,
1997.

HISTORICAL CLUB GROWTH

<TABLE>
<CAPTION>
                                                             SEVEN
                                                             MONTHS
                                   YEAR ENDED MAY 31,        ENDED         YEAR ENDED      YEAR ENDED
                                  --------------------    DECEMBER 31,    DECEMBER 31,    DECEMBER 31,
                                  1996    1997    1998        1998            1999            2000
                                  ----    ----    ----    ------------    ------------    ------------
<S>                               <C>     <C>     <C>     <C>             <C>             <C>
Clubs at beginning of period....   25      28      35          49              69              86
Greenfield clubs................    2       3       1           4              14               9
Acquired clubs..................    1       5      13          16               4              11
Sold or relocated clubs.........   --      (1)     --          --              (1)             (1)
                                   --      --      --          --              --             ---
Clubs at end of period..........   28      35      49          69              86             105
                                   ==      ==      ==          ==              ==             ===
Number of partly owned clubs
  included at the end of
  period........................    5       7       4           4               4               2
</TABLE>

Note: The Company includes in the club count wholly owned and partly owned
      clubs. In addition, as of December 31, 2000 the Company managed three
      additional clubs in which it did not have an equity stake.

INTRODUCTION

     The Company is one of the two leading owners and operators of fitness clubs
in the Northeast and Mid-Atlantic regions of the United States. As of December
31, 2000, the Company operated 105 clubs that collectively served approximately
278,000 members. The Company develops clusters of clubs to serve densely
populated major metropolitan regions in which a high percentage of the
population commutes to work. The Company services such populations by clustering
clubs near the highest concentrations of its target members' areas of both
employment and residence. The Company's target member is college-educated,
typically between the ages of 20 and 54 and earns an annual income in excess of
$50,000.

     The Company's goal is to develop the premier health club network in each of
the major metropolitan regions it enters. Management believes that clustering
clubs allows the Company to achieve strategic operating advantages that enhance
its ability to achieve this goal. In entering new regions, the Company develops
these clusters by initially opening or acquiring clubs located in the more
central urban markets of the region and then branching out from these urban
centers to suburbs and ancillary communities. Capitalizing on this clustering of
clubs, as of December 31, 2000, approximately 43.3% of the Company's members
participated in a membership plan that allows unlimited access to all of the
Company's clubs for a higher membership fee.

     The Company has executed this strategy successfully in the New York region
through the network of clubs it operates under its NYSC brand name. The Company
is the largest fitness club operator in Manhattan with 30 locations and operates
a total of 70 clubs under the NYSC name within a defined radius of New York

                                        16
<PAGE>   19

City. The Company operates 15 clubs in the Boston region, 13 clubs in the
Washington D.C. region under its BSC and WSC brand names respectively and has
begun establishing a similar cluster in the Philadelphia region under is PSC
brand name. The Company employs localized brand names for its clubs to create an
image and atmosphere consistent with the local community, and to foster the
recognition as a local network of quality fitness clubs rather than a national
chain.

     The Company's operating and selling expenses are comprised of both fixed
and variable costs. The fixed costs include salary expense, rent, utilities,
janitorial expenses and depreciation. Variable costs are primarily related to
sales commissions, advertising and supplies. As clubs mature and increase their
membership base, fixed costs are typically spread over an increasing revenue
base and operating margins tend to improve.

     During the last several years, the Company has increased revenues and
EBITDA by expanding its club base in New York, Washington, DC, Boston and
Philadelphia. As a result of the Company's expanding club base and relatively
fixed nature of the Company's operating costs, the Company's EBITDA has
increased from $5.1 million in fiscal 1996 to $49.4 million for the year ended
December 31, 2000, and EBITDA as a percentage of revenues has increased from
11.6% to 21.9% over the same period. Management expects growth in revenues, and
EBITDA to continue as the 67 clubs opened or acquired since the beginning of
1998 continue to mature. Based on the Company's historical experience, a new
club tends to experience significant increase in revenues during its first three
years of operation as it reaches maturity. Because there is relatively little
incremental cost associated with such increasing revenue, there is a greater
proportionate increase in profitability. The Company believes that the revenues,
EBITDA (before corporate overhead) and operating income (before corporate
overhead) of these 67 clubs will increase as they mature. As a result of the
Company's accelerated expansion, however, EBITDA and operating income margins
may be negatively impacted in the near term, as further new clubs are added.

MATURE CLUB REVENUE

     The Company defines mature clubs as those clubs that were operated by the
Company for the entire period of the period presented and that same entire
period of the preceeding year. Under this definition, mature clubs for periods
shown are those clubs that were operated by the Company for more than 24 months.
The Company's mature club revenue increased 18.6%, 16.0%, 16.8%, 12.6% and 9.9%,
for years ended December 31, 2000 and 1999, the seven months ended December 31,
1998, and fiscal 1998 and 1997, respectively.

NET LOSSES

     The Company incurred a net loss of $283,000, $560,000, and $936,000 for the
year ended December 31, 1998, the seven months ended December 31, 1998, and
fiscal 1997. Losses have resulted from a variety of costs, including, but not
limited to, amortization of goodwill and debt financing costs resulting from the
Company's acquisition strategy as well as compensation expense incurred in
connection with the vesting of certain stock options held by management.
Increased goodwill, amortization, depreciation and financing costs associated
with future acquisitions and greenfield club openings will impact profitability
and may result in net losses in the future.

                                        17
<PAGE>   20

RESULTS OF OPERATIONS

     The following table sets forth certain operating data as a percentage of
revenue for the periods indicated:

<TABLE>
<CAPTION>
                                                 SEVEN
                                              MONTHS ENDED           YEAR ENDED
                                              DECEMBER 31,          DECEMBER 31,
                                             --------------    -----------------------
                                             1997     1998     1998     1999     2000
                                             -----    -----    -----    -----    -----
<S>                                          <C>      <C>      <C>      <C>      <C>
Revenue....................................  100.0%   100.0%   100.0%   100.0%   100.0%
Operating Expenses:
Payroll and related........................   41.0     39.1     39.4     39.1     39.8
Club operating.............................   30.8     33.9     33.2     32.9     30.8
General and administrative.................    6.4      8.1      8.0      6.8      6.6
Depreciation and amortization..............    9.2     12.3     11.4     13.1     11.8
Compensation expense incurred in connection
  with stock options.......................    0.9      0.6      1.3      1.3      0.8
                                             -----    -----    -----    -----    -----
Operating income...........................   11.7      6.0      6.7      6.8     10.2
Interest expense, net of interest
  income...................................    7.6      7.3      7.1      6.4      5.8
                                             -----    -----    -----    -----    -----
Income (loss) before provision (benefit)
  for income tax...........................    4.1     (1.3)    (0.4)     0.4      4.4
Provision (benefit) for income tax.........    2.1     (0.5)    (0.1)     0.4      2.1
Extraordinary item.........................   (1.8)      --       --       --       --
Cumulative effect of change in accounting
  policy...................................   (0.2)      --       --       --       --
                                             -----    -----    -----    -----    -----
Net income (loss)..........................     --     (0.8)    (0.3)      --      2.3
Accreted dividends on preferred stock......    3.4      3.0      2.7      4.9      4.0
                                             -----    -----    -----    -----    -----
Net (loss) attributable to common
  stockholders.............................   (3.4)%   (3.8)%   (3.0)%   (4.9)%   (1.7)%
                                             =====    =====    =====    =====    =====
</TABLE>

                    YEAR ENDED DECEMBER 31, 2000 COMPARED TO
                        THE YEAR ENDED DECEMBER 31, 1999

     REVENUES.  Revenues increased $65.3 million or 40.9%, to $225.0 million
during 2000 from $159.8 million in 1999. This increase resulted from the 18
clubs opened or acquired in 1999 (approximately $18.1 million), and the 20 clubs
opened or acquired in 2000 (approximately $21.4 million). In addition, revenues
increased during 2000 by approximately $27.2 million or 18.6% at the Company's
mature clubs (clubs owned and operated for at least 24 months). The mature club
revenue increase is attributable to an 8.8% increase in membership, a 6.5%
increase in dues, and a 3.3% increase in ancilliary revenues. These increases
were offset by a $1.5 million decrease in revenue associated with a club
relocated in the first quarter of 2000).

     OPERATING EXPENSES.  Operating expenses increased $53.4 million, or 35.8%
to $202.3 million in 2000, from $148.9 million in 1999. This increase was due to
a 23.5% increase in total months of club operations to 1,113 in 2000 from 902 in
1999. The increase is also attributable to the clubs opened or acquired in 2000
including larger, multi-purpose clubs than that of the prior year's club base.

          Payroll and related increased by $27.3 million, or 43.7% to $89.7
     million in 2000, from $62.4 million in 1999. This increase was primarily
     attributable to the acquisition or opening of 20 clubs in 2000 and a full
     year of operating the 18 clubs opened or acquired in 1999. This increase
     was also attributable to an increase in personal training payroll and
     incentive based compensation.

          Club operating increased by $16.8 million, or 31.9% to $69.4 million
     in 2000, from $52.6 million in 1999. This increase is primarily
     attributable to the acquisition or opening of 20 clubs in 2000 and the
     additional expenses attributable to operating the 18 clubs opened or
     acquired in 1999.

                                        18
<PAGE>   21

          General and administrative increased by $3.8 million, or 35.3% to
     $14.8 million in 2000, from $10.9 million in 1999. This increase is
     attributable to expenses associated with our expansion, including the
     expansion of our corporate offices and staff and the enhancement of the
     Company's management information systems.

          Depreciation and amortization increased by $5.7 million, or 27.3% to
     $26.6 million in 2000, from $20.9 million in 1999. This increase is
     attributable to the increased fixed assets placed in service and intangible
     assets acquired arising out of acquisition or opening of new clubs.

          Compensation expense incurred in connection with stock options
     decreased by $206,000, or 10.1% to $1.8 million in 2000, from $2.0 million
     in 1999. The decrease in compensation expense is principally due to less
     compensatory stock options vesting in the year ended 2000 when compared to
     1999.

     INTEREST EXPENSE, NET OF INTEREST INCOME.  Interest expense, net of
interest income, increased $2.9 million to $13.1 million in 2000 from $10.2
million in 1999, primarily as a result of increased indebtedness due to the
$40.0 million of Senior Notes issued in June, 1999. The increase is also
attributable to the fact the Company began borrowing from its line of credit in
July of 2000 in order to consummate the purchase of the Boston chain, Health
Development Corporation ("HDC").

     PROVISION (BENEFIT) FOR INCOME TAX.  The provision for income taxes
increased $4.2 million from $571,000 in 1999 to $4.8 million in 2000. The
Company's effective tax rate decreased to 50% in 2000 from 92% in 1999. This
decrease is principally due to the change in the effective state rate which was
a greater percentage of pretax income in 1999 than in 2000. With the exception
of deferred tax assets of $284,000 related to certain state net operating loss
carry-forwards which have been fully reserved for, the Company expects future
taxable income to be sufficient to realize the $14.6 million of net deferred tax
assets.

     ACCRETED DIVIDENDS ON PREFERRED STOCK.  Accreted dividends on the Preferred
Stock increased $1.1 million to $9.0 million in 2000, from $7.9 million in 1999.
This increase is due to the compounding of accreted dividends.

                    YEAR ENDED DECEMBER 31, 1999 COMPARED TO
                        THE YEAR ENDED DECEMBER 31, 1998

     REVENUES.  Revenues increased $48.8 million or 43.9%, to $159.8 million
during 1999 from $111.0 million in 1998. This increase resulted from the 30
clubs opened or acquired in 1998 (approximately $25.6 million), and the 18 clubs
opened or acquired in 1999 (approximately $9.4 million). In addition, revenues
increased during 1999 by approximately $13.8 million or 16% at the Company's
mature clubs. The mature club revenue increase is attributable to an 8.1%
increase in membership, a 6.8% increase in dues, and a 1.1% increase in
ancilliary revenues.

     OPERATING EXPENSES.  Operating expenses increased $45.4 million, or 43.8%
to $148.9 million in 1999, from $103.6 million in 1998. This increase was
primarily due to a 45.8% increase in total months of club operations to 901 in
1999 from 618 in 1998, as highlighted by the following factors:

          Payroll and related increased by $18.7 million, or 42.9% to $62.4
     million in 1999, from $43.7 million in 1998. This increase was primarily
     attributable to the acquisition or opening of 18 clubs in 1999 and a full
     year of operating the 30 clubs opened or acquired in 1998.

          Club operating increased by $15.8 million, or 42.7% to $52.6 million
     in 1999, from $36.9 million in 1998. This increase is primarily
     attributable to the acquisition or opening of 18 clubs in 1999 and the
     additional expenses attributable to operating the 30 clubs opened or
     acquired in 1998.

          General and administrative increased by $2.0 million, or 22.4% to
     $10.9 million in 1999, from $8.9 million in 1998. This increase is
     attributable to expenses associated with our expansion, including the
     expansion of our corporate office and staff. In March, 1999, our membership
     billing processing center was moved to a purpose-built location separate
     from our corporate office.

                                        19
<PAGE>   22

          Depreciation and amortization increased by $8.3 million, or 66.0% to
     $20.9 million in 1999, from $12.6 million in 1998. This increase is
     attributable to the increased fixed assets placed in service and intangible
     assets acquired arising out of acquisition or opening of new clubs.

          Compensation expense incurred in connection with stock options
     increased by $563,000, or 38.1% to $2.0 million in 1999, from $1.5 million
     in 1998. The increase in compensation expense is principally due to more
     stock options vesting in the year ended 1999 when compared to 1998.

     INTEREST EXPENSE, NET OF INTEREST INCOME.  Interest expense, net of
interest income, increased $2.3 million to $10.2 million in fiscal 1999 from
$7.9 million in 1998, primarily as a result of increased indebtedness due to the
$40.0 million of Senior Notes issued in June, 1999.

     PROVISION (BENEFIT) FOR INCOME TAX.  Provision for income tax (benefit)
changed by $727,000 to a provision of $571,000 in 1999 from a benefit of
($156,000) in 1998. In 1999, the Company's effective tax rate was increased
principally due to non-deductible expenses, state minimum taxes and changes in
state tax rates. With the exception of deferred tax assets of $284,000 related
to certain state net operating loss carry-forwards which have been fully
reserved for, the Company expects future taxable income to be sufficient to
realize the $12.1 million of net deferred tax assets. Because the profitability
of clubs improve with maturation, the company expects increases in profitability
as the 48 clubs opened or acquired in 1998 and 1999 mature.

     ACCRETED DIVIDENDS ON PREFERRED STOCK.  Accreted dividends on the Preferred
Stock increased $4.8 million to $7.9 million during 1999, from $3.0 million in
1998. This increase is due to the issuance of Redeemable Senior Preferred Stock
in November, 1998.

                SEVEN MONTHS ENDED DECEMBER 31, 1998 COMPARED TO
                      SEVEN MONTHS ENDED DECEMBER 31, 1997

     REVENUES.  Revenues increased approximately $28.7 million, or 66.7%, to
$71.7 million during the seven months ended December 31, 1998 from $43.0 million
in the seven months ended December 31, 1997. This increase resulted primarily
from maturation of the 16 clubs opened or acquired during fiscal 1998
(approximately $13.2 million) and the 20 clubs opened or acquired during the
seven months ended December 31, 1998 (approximately $8.0 million). In addition,
revenues increased during the period by $7.1 million at the Company's mature
clubs resulting from increased membership and non membership revenues such as
personal training.

     OPERATING EXPENSES.  Operating expenses increased $29.3 million, or 77.4%,
to $67.3 million in the seven months ended December 31, 1998, from $38.0 million
in the seven months ended December 31, 1997. The increase was primarily due to
an 89.5% increase in total months of club operations to 417 in the seven months
ended December 31, 1998 from 220 in the seven months ended December 31, 1997, as
highlighted by the following factors:

          Payroll and related increased by $10.4 million, or 58.9% to $28.0
     million in the seven months ended December 31, 1998, from $17.6 million in
     the seven months ended December 31, 1997. This increase was attributable to
     the acquisition or opening of 16 clubs in fiscal 1998 and 20 clubs during
     the seven month period ended December 31, 1998.

          Club operating increased by $11.0 million, or 83.0% to $24.3 million
     in the seven months ended December 31, 1998, from $13.3 million in the
     seven months ended December 31, 1997. This increase is attributable to the
     acquisition or opening of 16 clubs in fiscal 1998 and 20 clubs during the
     seven month period ended December 31, 1998.

          General and administrative increased by $3.1 million, or 112.5% to
     $5.8 million in the seven months ended December 31, 1998, from $2.7
     million, in the seven months ended December 31, 1997. This increase is
     attributable to expenses associated with the Company's expansion, including
     the expansion of the Company's corporate office and upgrade of the
     Company's management information systems. In addition the Company wrote-off
     $169,000 of expenses associated with the preparation for an initial public
     offering, which has been postponed due to market volatility.

                                        20
<PAGE>   23

          Depreciation and amortization increased by $4.9 million, or 123.6% to
     $8.8 million in the seven months ended December 31, 1998, from $3.9 million
     in the seven months ended December 31, 1997. This increase is attributable
     primarily to the increased fixed and intangible assets arising out of new
     club acquisitions and openings during the seven months ended December 31,
     1998, and depreciation and amortization for fixed asset additions,
     acquisitions or openings since December 31, 1997. Fixed and intangible
     assets acquired during the last five months ended May 31, 1998 totaled
     $12.6 million and $9.8 million, respectively. Fixed and intangible assets
     acquired during the first seven months ended December 31, 1998 totaled
     $33.0 million and $20.7 million respectively.

          Compensation expense incurred in connection with stock options
     increased $37,000, or 9.3% to $434,000 in the seven months ended December
     31, 1998, from $397,000 in the seven months ended December 31, 1997, as a
     result of a compounding feature in the calculation of dividends on the
     Preferred stock options.

     INTEREST EXPENSE, NET OF INTEREST INCOME.  Interest expense, net of
interest income, increased $2.0 million to $5.3 million during the seven months
ended December 31, 1998, from $3.3 million in the seven months ended December
31, 1997. The increased level of interest expense was primarily due to a full
period of interest related to the Senior Notes (drawn down in October 1997), as
well as drawings under the line of credit to fund certain acquisitions during
1998. Interest income decreased $254,000 to $272,000 during the seven months
ended December 31, 1998, from $526,000 in the seven months ended December 31,
1997. The decreased level of interest income was primarily due to lower cash on
hand as the Company invested in acquisitions and new club construction.

     PROVISION (BENEFIT) FOR INCOME TAX.  The income tax benefit for the seven
months ended December 31, 1998 was ($399,000) compared to a tax expense of
$888,000 for the seven months ended December 31, 1997. During the seven months
ended December 31, 1998, the Company's effective tax rate was impacted by net
operating losses incurred by certain clubs located in states where such losses
could not currently be utilized and higher tax-exempt interest income.

     CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY.  In accordance with the
American Institute of Certified Public Accountants' ("AICPA") Statement of
Position 98-5 (Accounting for the Costs of Start-up Activities), the Company has
expensed all Organizational Costs capitalized in previous fiscal years.
Accordingly, $158,000 was written off, $88,000 net of a tax effect of $70,000.

     EXTRAORDINARY ITEM.  During the seven months ended December 31, 1997, the
Company issued 9 3/4% Senior Notes due 2004 pursuant to which the Company repaid
its existing indebtedness. Accordingly, previously capitalized fees and expenses
of $1.4 million relating to the former debt were written off, $782,000 net of a
tax effect of $624,000.

     ACCRETED DIVIDENDS ON PREFERRED STOCK.  Accreted dividends on the preferred
stock increased $0.6 million to $2.1 million in the seven months ended December
31, 1998, from $1.5 million in the seven months ended December 31, 1997. This
increase is as a result of a compounding feature in the calculation of the
accretion of dividends on the Series A and B preferred stock, as well as
dividends subsequent to the issuance of redeemable senior preferred stock.

LIQUIDITY AND CAPITAL RESOURCES

     Historically, the Company has satisfied its liquidity needs through cash
from operations and various borrowing arrangements. Principal liquidity needs
have included the acquisition and development of new clubs, debt service
requirements and other capital expenditures necessary to maintain and renovate
existing clubs.

     Operating Activities.  Net cash provided by operating activities for the
year ended December 31, 2000 was $40.6 million compared to $29.5 million during
the year ended December 31, 1999. The increase in cash provided by operating
activities was primarily due an increase in the number of mature clubs and to
improved performance by these mature clubs, offset by recently opened or
acquired clubs which may be immature and not yet operating at normal operating
margins. Excluding cash and cash equivalents, the Company normally operates with
a working capital deficit because it receives dues or fee revenue either (i)
during the month

                                        21
<PAGE>   24

services are rendered, or (ii) when paid-in-full, in advance. As a result, the
Company has no material accounts receivable. The Company also records a deferred
revenue liability, because initiation fees are received at enrollment and are
recognized over the estimated average term of membership. Management believes
that the Company's working capital deficit is an important source of cash flow
from operating activities that it believes will continue to grow as the
Company's membership revenues increase.

     Investing Activities.  The Company invested $71.5 million and $56.3 million
in capital expenditures and asset acquisitions during the years ended December
31, 2000 and 1999, respectively, primarily as a result of the Company's
expansion efforts. The Company estimates that for the year ended December 31,
2001, it will invest an additional $66.0 million in capital expenditures and
asset acquisitions, which includes $11.4 million that management intends to
invest to expand and renovate certain existing clubs, $7.6 million to maintain
existing clubs and $5.8 million to further upgrade its management information
system. These expenditures will be funded by cash flow generated from
operations, available cash and credit facilities. In July 2000, the Company
acquired Health Development Corporation for $18.7 million in cash. Including
$525,000 of transaction costs, the aggregate purchase price amounts to $19.2
million. The acquisition was financed with $6.0 million of line of credit
borrowings and cash on hand. HDC's operations included eight fitness clubs in
Massachusetts and one fitness club in New Hampshire. HDC also provided
management services at three facilities in the Boston region.

     Financing Activities.  As of December 31, 2000, the Company has
approximately $14.2 million available under the current Credit Facility and
$20.0 million under the Subordinated Credit Facility, which mature in October
2002 and December 2004 respectively, and have no scheduled amortization
requirements. The Credit Facility allows for maximum borrowings of $25.0
million. The line of credit carries interest at the Company's option based upon
the Eurodollar borrowing rate plus 2.50% or the bank's prime rate plus 1.50%, as
defined and the Company is required to pay a commitment commission of 0.375% per
annum based upon the daily unutilized amount. There were $6.0 million of
Eurodollar borrowings and $3.0 million of prime rate borrowings outstanding
against this line as of December 31, 2000. The amount available for borrowing
has been further reduced by outstanding letters of credit totaling $1.8 million.
The interest rates charged on the Eurodollar and prime rate borrowings
outstanding at December 31, 2000 were 9.18% and 11.00%, respectively. The line,
as amended, contains various covenants including interest coverage and a
leverage ratio as well as restrictions on the payment of dividends. Although
management believes that the Company will be able to obtain or generate
sufficient funds to finance the Company's current operating and growth plans
through the end of 2001, any material acceleration or expansion of that plan
through additional greenfields or acquisitions (to the extent such acquisitions
include cash payments) may require the Company to pursue additional sources of
financing prior to the end of 2001. There can be no assurance that such
financing will be available or that it will be available on acceptable terms.
The inability to finance such further or accelerated expansion on acceptable
terms may negatively impact the Company's competitive position and materially
adversely affect the Company's business, results of operations or financial
condition. The Credit Facility accrues interest at variable rates based on
market conditions, accordingly, future increases in interest rates could have a
negative impact on net income.

     In November 2000 the Company entered into a Subordinated Credit Agreement
(the "Subordinated Agreement") with an affiliate of a director and stockholder
of the Company. This Subordinated Agreement provides for up to $20.0 million of
principal borrowings and expires December 31, 2004. Interest on principal
borrowings accrues at 13% per annum; 10% of which is payable on a monthly basis
and the remaining 3% is accruable, at the option of the Company, through
maturity. The total amount of accrued and unpaid interest may not exceed $2.5
million. The Company is charged a fee of .083% per month based on the portion of
the facility not utilized. In connection with this agreement the Company paid a
commitment fee of $225,000 to the lender, approximately $73,000 of legal fees,
and the Company committed to issue 16,000 shares of common stock to the lender.
The commitment to issue common stock is at the earlier of the Company's initial
borrowing under the Agreement or its termination. The estimated fair value of
these shares of common stock of $1.4 million and the aforementioned commitment
and legal fees were accounted for as deferred financing costs. In addition, the
Company has agreed to issue an additional 7,000 shares of common stock to the
lender

                                        22
<PAGE>   25

in the event that the agreement has not been terminated prior to November 30,
2002. The Agreement contains similar, but less restrictive covenants than those
with the line of credit, as amended.

     In June, 1999, the Company issued $40.0 million Senior Notes thereby
increasing the total Senior Notes outstanding to $125.0 million. These notes
were issued at a price of 98.75%, providing the Company with $39.5 million of
proceeds before expenses related to the issuance. After payment of fees and
expenses of $3.9 million, the Company received net proceeds of $35.6 million.
Other cash flow financing activities during 1998 and 1999 include borrowings
under the Credit Facility, the repayment of long-term debt, and the issuance of
redeemable senior preferred stock "Senior Stock".

     In November 1998, the Company sold $40.0 million of Senior stock. After
payment of fees and expenses of approximately $400,000 the Company received net
proceeds of $39.6 million. The Senior stock is redeemable in November 2008, and
carries a cumulative 12.0% annual dividend which is added to the liquidation
value of such preferred shares, if not paid in cash, at the option of the
Company.

     In October 1997, the Company issued $85.0 million Senior Notes and entered
into the Credit Facility. After payment of fees and expenses of $3.3 million,
the Company received net proceeds of $81.7 million, of which $41.5 million was
used for the repayment of certain indebtedness. The Senior Notes contain
restrictive covenants and restrict the payment of dividends. The Credit Facility
notes contain restrictive covenants, including a leverage ratio and interest
coverage ratio and dividend payment restrictions and is collaterlized by all the
assets of the Company.

  Effect of Recent Changes in Accounting Standards

     The Company believes future adoption of recently issued accounting
standards will not have a material impact on the financial statements.

INFLATION

     The Company believes that inflation has not had a material impact on its
results of operations for the three year period ended December 31, 2000.

FORWARD-LOOKING STATEMENTS

     Certain statements in this Annual Report on Form 10-K of the Company for
the year ended December 31, 2000 are forward-looking statements, including,
without limitation, statements regarding future financial results and
performance, potential sales revenue, legal contingencies and tax benefits.
These statements are subject to various risks and uncertainties, many of which
are outside the control of the Company, including the level of market demand for
the Company's services, competitive pressures, the ability to achieve reductions
in operating costs and to continue to integrate acquisitions, environmental
matters, the application of Federal and state tax laws and regulations, and
other specific factors discussed herein and in other Securities and Exchange
Commission filings by the Company. The information contained herein represents
management's best judgement as of the date hereof based on information currently
available; however, the Company does not intend to update this information to
reflect development or information obtained after the date hereof and disclaims
any legal obligation to the contrary.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

     Not applicable

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Registrant's financial statements and supplementary data are listed in
the index appearing under item 14(a)(1) and 14(a)(2) .

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     None.

                                        23
<PAGE>   26

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The following table sets forth the names, ages and a brief account of the
business experience of each person who is currently a director or executive
officer of the Company.

<TABLE>
<CAPTION>
NAME                                           AGE                       POSITION
----                                           ---                       --------
<S>                                            <C>    <C>
Mark Smith...................................  41     Chief Executive Officer and Director
Robert Giardina..............................  43     President and Chief Operating Officer
Alexander Alimanestianu......................  41     Executive Vice President, Development
Richard Pyle.................................  42     Executive Vice President and Chief Financial
                                                      Officer
Deborah Smith................................  41     Senior Vice President, Operations
Keith Alessi.................................  46     Director
Paul Arnold..................................  54     Director
Bruce Bruckmann..............................  47     Director
Stephen Edwards..............................  37     Director
Jason Fish...................................  43     Director
</TABLE>

     Mark Smith joined the Company in 1985 and was appointed Chief Executive
Officer in 1995. Prior to this appointment, he held the position of Executive
Vice President of Development and International Operations. Mr. Smith has also
served as a director of the Company since September 1995. Mr. Smith has had
primary responsibility for the development and/or acquisition of the Company's
clubs since 1990, as well as responsibility for the Company's Managed Clubs in
Switzerland. Before joining the Company, Mr. Smith was a chartered accountant
with Coopers & Lybrand in New York City, London and New Zealand, and a
professional squash player.

     Robert Giardina has served as President and Chief Operating Officer of the
Company since 1992. Mr. Giardina joined the Company in 1981 (when the Company
had four clubs) after six years of employment with other fitness club companies.
With over 20 years of experience in the club industry, Mr. Giardina has
expertise in virtually every aspect of facility management and club operations.
In addition to operations, Mr. Giardina has primary responsibility for sales and
marketing.

     Alexander Alimanestianu joined the Company in 1990, and became Executive
Vice President, Development in 1995. From 1990 to 1995, Mr. Alimanestianu served
as Vice President and Senior Vice President. Before joining the Company, he
worked as a corporate attorney for six years with one of the Company's outside
law firms. Mr. Alimanestianu has been involved in the development or acquisition
of over 90 of the Company's clubs.

     Richard Pyle, a British chartered accountant, joined the Company in 1987
and has been chiefly responsible for the Company's financial matters since that
time, as a Vice President in 1988, Senior Vice President and Chief Financial
Officer in 1992 and Executive Vice President in 1995, successively. Before
joining the Company, Mr. Pyle worked in public accounting (in the United States,
Bermuda, Spain and in England) specializing in the hospitality industry, and as
the corporate controller for a British public company in the leisure industry.

     Deborah Smith joined the Company in 1987, and served as Vice President
before her appointment as a Senior Vice President of Operations in 1995. Ms.
Smith has been responsible for the startup and operation of Company clubs in New
York, Switzerland, Maryland and Washington, DC. She oversees club operations in
all U.S. geographic areas.

     Keith Alessi has served as a director of the Company since April, 1997. Mr.
Alessi is an associate professor at the Washington and Lee University School of
Law. Mr. Alessi served as President, Chief Executive Officer and a director of
Telespectrum Worldwide, Inc. from March 1998 to April 2000. From May 1996 to
March 1998, Mr. Alessi served as Chairman, President and Chief Executive Officer
of Jackson

                                        24
<PAGE>   27

Hewitt, Inc. Prior to that, Mr. Alessi held various positions with Farm Fresh,
Inc. including Chief Financial Officer and President.

     Paul Arnold has served as a director of the Company since April, 1997. Mr.
Arnold has served as President and Chief Executive Officer of Cort Business
Services, Inc., a leading national supplier of high end rental furniture since
1992.

     Bruce Bruckmann has served as a director of the Company since December,
1996. Since 1994, Mr. Bruckmann has served as Managing Director of BRS. From
1983 until 1994, Mr. Bruckmann served as an officer and subsequently a Managing
Director of Citicorp Venture Capital, Ltd. ("CVC"). Mr. Bruckmann is currently a
director of Mediq Inc., Penhall International, Inc., Jitney Jungle Stores of
America, Inc., Mohawk Industries, Inc., AmeriSource Health Corporation,
California Pizza Kitchen, Inc. and Anvil Knitwear, Inc. and a director of
several private companies.

     Stephen Edwards has served as a director of the Company since December,
1996. Since 1994, Mr. Edwards has served as Managing Director of BRS. From 1993
until 1994, Mr. Edwards served as an officer of CVC. From 1988 through 1991, he
was an associate of CVC. Prior to joining CVC, Mr. Edwards worked with
Citicorp/Citibank in various corporate finance positions. Mr. Edwards is
currently a director of Anvil Knitwear, Inc. and O'Sullivan Industries and a
director of several private companies.

     Jason Fish has been a director of the Company since December, 1996. Mr.
Fish is the co-founder and President of CapitalSource Holdings, L.L.C., a
position he has held since June, 2000. Prior to founding CapitalSource, Mr. Fish
had been a Managing Member of Farallon Capital Management, L.L.C. ("FCM") and
Farallon Partners, L.L.C., the Farallon's two management entities, since April
1996. Mr. Fish was a General Partner of the Farallon investment partnerships and
a Managing Director of FCM's predecessor, Farallon Capital Management, Inc.,
from 1990 to 1996. Mr. Fish is currently a director of Gardenburger, Inc.

ITEM 11.  EXECUTIVE COMPENSATION

     The following summarizes, for the fiscal year indicated, the principal
components of compensation for the Company's Chief Executive Officer and the
four highest compensated executive officers (collectively, the "named executive
officers"). The compensation set forth below fully reflects compensation for
work performed on behalf of the Company.

<TABLE>
<CAPTION>
                                                             OTHER ANNUAL       LONG-TERM COMPENSATION
NAME AND                              SALARY     BONUS(1)    COMPENSATION        AWARDS COMMON STOCK
PRINCIPAL POSITION          PERIOD      ($)        ($)            ($)         UNDERLYING OPTIONS/SARS(#)
------------------          ------    -------    --------    -------------    --------------------------
                                              ANNUAL COMPENSATION
<S>                         <C>       <C>        <C>         <C>              <C>
Mark Smith................  2000(2)   397,752    540,000          --                       --
  Chief Executive Officer   1999(2)   379,979    338,000          --                       --
                            1998(3)   216,600    209,764          --                       --
                            1998(4)   360,500    330,000          --                       --
Robert Giardina...........  2000(2)   377,237    413,000          --                       --
  President and Chief       1999(2)   360,381    257,260          --                       --
  Operating Officer         1998(3)   205,429    158,782          --                       --
                            1998(4)   341,906    250,000          --                       --
Richard Pyle..............  2000(2)   206,764    317,000          --                       --
  Executive Vice President  1999(2)   197,525    196,855          --                       --
  and Chief Financial
     Officer                1998(3)   112,596    119,626          --                       --
                            1998(4)   187,399    187,500          --                       --
Alexander Alimanestianu...  2000(2)   206,764    317,000          --                       --
  Executive Vice            1999(2)   197,525    196,855          --                       --
  President, Development    1998(3)   112,596    119,626          --                       --
                            1998(4)   187,399    187,500          --                       --
</TABLE>

                                        25
<PAGE>   28

<TABLE>
<CAPTION>
                                                             OTHER ANNUAL       LONG-TERM COMPENSATION
NAME AND                              SALARY     BONUS(1)    COMPENSATION        AWARDS COMMON STOCK
PRINCIPAL POSITION          PERIOD      ($)        ($)            ($)         UNDERLYING OPTIONS/SARS(#)
------------------          ------    -------    --------    -------------    --------------------------
                                              ANNUAL COMPENSATION
<S>                         <C>       <C>        <C>         <C>              <C>
Deborah Smith.............  2000(2)   166,261    216,000
  Senior Vice President,    1999(2)   158,832    130,511          --                       --
  Operations                1998(3)    90,539     79,391          --                       --
                            1998(4)   141,100    125,000          --                      400
</TABLE>

---------------
(1) Includes annual bonus payments under the Company's Annual Bonus Plan.

(2) Includes the twelve month period ended December 31.

(3) Includes the seven months ended December 31, 1998.

(4) Includes the twelve month period ended May 31.

OPTION/SAR GRANTS DURING THE YEAR ENDED DECEMBER 31, 2000

     There were no options granted to named executive officers by the Company
during the year ended December 31, 2000.

AGGREGATED OPTION/SAR EXERCISES DURING THE YEARS ENDED DECEMBER 31, 2000 AND
2000 YEAR-END OPTION/ SAR VALUES

     The following summarizes exercises of stock options (granted in prior
years) by the named executive officers during the year ended December 31, 2000
as well as the number and value of all unexercised options held by the named
executive officers as of December 31, 2000.

<TABLE>
<CAPTION>
                                                       NUMBER OF SECURITIES         VALUE OF UNEXERCISED
                                                           OPTIONS/SARS                 IN-THE-MONEY
                                                           AT FY-END(#)                 OPTIONS/SARS
                           SHARES                     UNDERLYING UNEXERCISED           AT FY-END($)(1)
                         ACQUIRED ON      VALUE      EXERCISABLE/UNEXERCISABLE    EXERCISABLE/UNEXERCISABLE
                         EXERCISE(#)   REALIZED($)   -------------------------   ---------------------------
NAME                       COMMON        COMMON        COMMON       PREFERRED       COMMON        PREFERRED
----                     -----------   -----------   -----------   -----------   -------------   -----------
<S>                      <C>           <C>           <C>           <C>           <C>             <C>
Mark Smith.............      --            --           8,830/0     42,812/0         653,420/0   1,852,884/0
Robert Giardina........      --            --           8,829/0     32,793/0         653,346/0   1,419,288/0
Richard Pyle...........      --            --           8,828/0     27,569/0         653,272/0   1,193,186/0
Alexander
  Alimanestianu........      --            --           8,828/0     27,199/0         653,272/0   1,177,187/0
Deborah Smith..........      --            --         5,637/113      9,530/0     412,391/6,509     412,471/0
</TABLE>

---------------
(1) Value realized is based upon the fair market value of the stock at the
    exercise date minus the exercise price. Fair market value was determined in
    good faith by the Board of Directors and was based upon the historical and
    projected financial performance of the Company.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The current members of the Compensation Committee are Bruce Bruckmann,
Stephen Edwards and Mark Smith. Messrs. Bruckmann and Edwards are non-employee
directors of the Company.

MANAGEMENT EQUITY AGREEMENTS

     Simultaneously with a recapitalization, the Company entered into Executive
Stock Agreements with certain of the officers and other key employees of the
Company. Pursuant to the Executive Stock Agreements, the executives each have
purchased shares of Common Stock and/or shares of Series B Preferred of the
Company at a purchase price of $1.00 per share of Common Stock and $35.00 per
share of Series B Preferred Stock.

                                        26
<PAGE>   29

COMPANY BENEFIT PLANS

     The Company maintains a 401(k) defined contribution plan and is subject to
the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA").
The Plan provides for the Company to make discretionary contributions; however,
the Company elected not to make contributions for the year ended May 31, 1998,
the seven months ended December 31, 1998, and the years ended December 31, 1999
and 2000. The Plan was amended, effective January 1, 2001, to provide for an
employer matching contribution in an amount equal to 25% of the participant's
contribution with a limit of five hundred dollars per annum.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth (as of December 31, 2000) certain
information with respect to the beneficial ownership of the Common Stock and
Preferred Stock by: (i) each person or entity who owns of record or beneficially
more than 5% or more of any class of the Company's voting securities; (ii) each
named executive officer and director of the Company; and (iii) all directors and
named executive officers of the Company as a group.

<TABLE>
<CAPTION>
                                    COMMON      PERCENTAGE OF
                                    STOCK           COMMON         REDEEMABLE
                                 BENEFICIALLY       STOCK            SENIOR           SERIES A          SERIES B
NAME                               OWNED(1)     OUTSTANDING(1)   PREFERRED STOCK   PREFERRED STOCK   PREFERRED STOCK
----                             ------------   --------------   ---------------   ---------------   ---------------
<S>                              <C>            <C>              <C>               <C>               <C>
BRS(2)
  126 East 56th Street,
  29th Floor
  New York, New York 10022.....     504,456          38.3%               --            104,330                --
The Farallon Entities(3)
  One Maritime Plaza,
  Suite 1325
  San Francisco, California
  94111........................     270,091          20.5%           20,000             41,045                --
The Canterbury Entities(4)
  600 Fifth Avenue,
  23rd Floor
  New York, New York 10020.....     139,437          10.6%           15,000                 --                --
Rosewood Capital L.P.(5)
  One Maritime Plaza,
  Suite 1330
  San Francisco, California
  94111........................      17,908           1.4%            5,000                 --                --
EXECUTIVE OFFICERS AND
  DIRECTORS:
Mark Smith(6)..................      70,547           5.4%               --                 --            42,812
Robert Giardina(6).............      56,103           4.3%               --                 --            32,793
Richard Pyle(6)................      48,571           3.7%               --                 --            27,569
Alexander Alimanestianu(6).....      48,038           3.6%               --                 --            27,199
Deborah Smith(6)...............      20,484           1.6%               --                 --            10,080
Bruce C. Bruckmann(7)..........     517,642          39.3%               --            107,057                --
Stehpen Edwards(8).............     504,456          38.3%               --            104,330                --
Jason Fish(9)..................     270,091          20.5%           20,000             41,045                --
Paul Arnold....................      *              *                    --                591                --
Keith Alessi...................      *              *                    --                591                --
EXECUTIVE OFFICERS AND
  DIRECTORS AS A GROUP:
10 Persons(10).................   1,037,191          78.7%           20,000            149,284           140,453
</TABLE>

---------------
  *  Represents less than 1%.

 (1) Beneficial ownership is determined in accordance with Rule 13d-3 under the
     Exchange Act. In computing the number of shares beneficially owned by a
     person and the percentage ownership of that

                                        27
<PAGE>   30

     person, shares of Common Stock subject to options held by that person that
     are currently exercisable or exercisable within 60 days of March 15, 2000
     are deemed outstanding. Such shares, however, are not deemed outstanding
     for the purposes of computing the percentage ownership of any other person.

 (2) Excludes shares held individually by Mr. Bruckmann and other individuals
     (and affiliates and family members thereof), each of whom are employed by
     BRS.

 (3) Includes shares held by each of Farallon Capital Partners, L.P., Farallon
     Capital Institutional Partners, L.P., Farallon Capital Institutional
     Partners II, L.P. and R.R. Capital Partners, L.P. (the "Farallon
     Entities"). Farallon Partners, L.L.C. is the general partner of each of the
     Farallon Entities. Farallon Partners, L.L.C. disclaims beneficial ownership
     of such shares. Also includes warrants to purchase 71,630 shares of Common
     Stock with an exercise price of $.01 per share and an expiration date of
     November 30, 2008.

 (4) Includes a warrant to purchase 75,714 shares of Common Stock with an
     exercise price of $.01 per share and an expiration date of December 10,
     2006 and warrants to purchase 53,723 shares of Common Stock with an
     exercise price of $.01 and an expiration date of November 15, 2008.

 (5) Includes warrants to purchase 17,908 shares of Common Stock with an
     exercise price of $.01 per share and an expiration date of November 30,
     2008.

 (6) Includes options to acquire, exercisable within 60 days, Common Stock, and
     Series B Preferred Stock options, exercisable within 60 days, pursuant to
     the Old Option Plan and the Preferred Option Plan, respectively. Messrs.
     Smith, Giardina, Pyle, Alimanestianu and Ms. Smith each hold such options
     on 8,830, 8,829, 8,828, 8,828 and 5,430 shares of Common Stock,
     respectively. All shares of Series B Preferred Stock beneficially owned by
     such persons are in the form of Series B Options, except with respect to
     Ms. Smith only, 9,530 shares are in the form of Series B Options. The
     address for each of these named executive officers is the same as the
     address of the Company's principal executive offices.

 (7) Includes 504,456 shares held by BRS, and approximately 2,276 shares held by
     certain other family members of Mr. Bruckmann. Mr. Bruckmann disclaims
     beneficial ownership of such shares held by BRS.

 (8) Includes shares held by BRS. Mr. Edwards disclaims beneficial ownership of
     such shares.

 (9) Includes shares held by each of the Farallon Entities. Mr. Fish is the
     founder of CapitalSource L.L.C. an affiliate of the Farallon Entities. Mr.
     Fish disclaims beneficial ownership of such shares.

(10) Includes (i) shares held by BRS, which may be deemed to be owned
     beneficially by Messrs. Bruckmann and Edwards, and (ii) shares held by the
     Farallon Entities, which may be deemed to be owned beneficially by Mr.
     Fish.

Excluding the shares beneficially owned by BRS and the Farallon Entities, the
directors and named executive officers as a group beneficially own (i) 249,458
shares of Common Stock (which represents approximately 18.9% of the Common Stock
on a fully diluted basis), (ii) no shares of Redeemable Senior Preferred Stock,
(iii) 1,182 shares of Series A Preferred Stock, and (iv) 140,453 shares of
Series B Preferred Stock.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

REDEEMABLE SENIOR PREFERRED STOCK

     In November 1998, the Company issued 40,000 shares of Redeemable Senior
Preferred Stock ("Senior"). After the payment of fees and expenses of
approximately $400,000 the Company received net proceeds of approximately $39.6
million. The Senior stock is redeemable in November 2008. The Senior stock may,
at the option of the holder, be converted into Common stock upon the initial
public offering of common stock of the Company.

REGISTRATION RIGHTS AGREEMENT

     In connection with the Recapitalization, the Company, BRS, the Farallon
Entities, Canterbury Mezzanine Capital, L.P. ("CMC"), certain members of
management and other shareholders of the Company entered into a Registration
Rights Agreement, dated December 10, 1996 (as amended on November 13, 1998, in
connection with the issuance of Senior Preferred Stock, the "Registration Rights
Agreement"). Pursuant to

                                        28
<PAGE>   31

the terms of the Registration Rights Agreement, BRS, the Farallon Entities and
CMC have the right to require the Company, at the expense of the Company and
subject to certain limitations, to register under the Securities Act all or part
of the shares of Common Stock (the "Registrable Securities") held by them. BRS
is entitled to demand up to three long-form registrations at any time and
unlimited short-form registrations. Farallon is entitled to demand one long-form
registration (but only one year after the Company has consummated an initial
registered public offering of its Common Stock) and up to three short-form
registrations. CMC is entitled to demand up to two short-form registrations.

     All holders of Registrable Securities are entitled to an unlimited number
of "piggyback" registrations, with the Company paying all expenses of the
Offering, whenever the Company proposes to register its Common Stock under the
Securities Act. Each such holder is subject to certain pro rata limitations on
its ability to participate in such a "piggyback" registration. In addition,
pursuant to the Registration Rights Agreement, the Company has agreed to
indemnify all holders of Registrable Securities against certain liabilities,
including certain liabilities under the Securities Act.

PROFESSIONAL SERVICES AGREEMENT

     In connection with the Recapitalization, Bruckmann, Rosser, Sherrill & Co.,
Inc. ("BRS Co."), an affiliate of BRS, and the Company entered into a
Professional Services Agreement, whereby BRS Co. agreed to provide certain
advisory and consulting services to the Company. In exchange for such services,
BRS Co. receives an annual fee of $250,000 per calendar year while they own at
least 20.0% of the outstanding Common Stock of the Company.

SUBORDINATED CREDIT AGREEMENT

     In November 2000 the Company entered into a Subordinated Credit Agreement
(the "Subordinated Agreement") with an affiliate of a director and stockholder
of the Company. This Subordinated Agreement provides for up to $20.0 million of
principal borrowings and expires December 31, 2004. Interest on principal
borrowings accrues at 13% per annum; 10% of which is payable on a monthly basis
and the remaining 3% is accruable, at the option of the Company, through
maturity. The total amount of accrued and unpaid interest may not exceed $2.5
million. The Company is charged a fee of 0.083% per month based on the portion
of the facility not utilized. In connection with this agreement the Company paid
a commitment fee of $225,000 to the lender, approximately $73,000 of legal fees,
and the Company committed to issue 16,000 shares of common stock to the lender.
The commitment to issue common stock is at the earlier of the Company's initial
principal borrowing under the Agreement or its termination. The estimated fair
value of these shares of common stock of $1.4 million and the aforementioned
commitment and legal fees were accounted for as deferred financing costs. In
addition, the Company has agreed to issue an additional 7,000 shares of common
stock to the lender in the event that the agreement has not been terminated
prior to November 30, 2002.

                                        29
<PAGE>   32

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 9, 2001.

                                          TOWN SPORTS INTERNATIONAL, INC.

                                          By: /s/ MARK SMITH
                                            ------------------------------------
                                            Mark Smith
                                            Chief Executive Officer
                                            (principal executive officer)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

By: /s/ MARK SMITH
    --------------------------------------------------------
    Mark Smith
    Chief Executive Officer
    (principal executive officer)

By: /s/ RICHARD PYLE
    --------------------------------------------------------
    Richard Pyle
    Executive Vice President and Chief Financial Officer
    (principal financial and accounting officer)

By: /s/ KEITH ALESSI
    --------------------------------------------------------
    Keith Alessi
    Director

By: /s/ PAUL ARNOLD
    --------------------------------------------------------
    Paul Arnold
    Director

By: /s/ BRUCE BRUCKMAN
    --------------------------------------------------------
    Bruce Bruckmann
    Director

By: /s/ STEPHEN EDWARDS
    --------------------------------------------------------
    Stephen Edwards
    Director

By: /s/ JASON FISH
    --------------------------------------------------------
    Jason Fish
    Director

                                        30
<PAGE>   33

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

     (a) Document List

     1.  Financial Statements

     The following consolidated financial statements of the Company are included
in Item 8:

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of independent accountants                              F-1
Consolidated balance sheets at December 31, 1999 and 2000      F-2
Consolidated statements of operations for the year ended May
  31, 1998, the seven months ended December 31, 1997
  (Unaudited), and 1998 and the years ended December 31,
  1999 and 2000                                                F-3
Consolidated statements of stockholders' deficit for the
  year ended May 31, 1998, the seven months ended December
  31, 1998 and the years ended December 31, 1999 and 2000      F-4
Consolidated statements of cash flows for the year ended May
  31, 1998, the seven months ended December 31, 1997
  (Unaudited), and 1998 and the years ended December 31,
  1999 and 2000                                                F-5
Notes to consolidated financial statements                     F-6
</TABLE>

     2.  Financial statement schedules

     All schedules for which provision is made in the applicable accounting
requirements of the Securities and Exchange Commission are not required or the
required information has been included within the financial statements or the
notes thereto.

     (b) Reports on Form 8-K

     July 28, 2000 Form 8-K filed in connection with the acquisition of Health
Development Corporation.

     (c) Exhibits:

<TABLE>
<C>    <S>
 2.1   Agreement and Plan of Merger dated as of November 8, 1996 by
       and among the Company, various Sellers and Option Holders
       and TSI Recapitalization Sub, Inc.+
 2.2   Amendment to Agreement and Plan of Merger dated as of
       December 10, 1996 among TSI Merger Sub, Inc., the Company
       and certain stockholders and option holders of the Company.+
 3.1   Amended and Restated Certificate of Incorporation of the
       Company.+
 3.2   By-Laws of the Company.+
 3.3   Certificate of Amendment of the Certificate of Incorporation
       of the Company, dated as of November 13, 1998.***
 4.1   Indenture dated as of October 16, 1997 between the Company
       and United States Trust Company of New York.+
 4.2   Purchase Agreement dated as of October 9, 1997 among the
       Company and BT Alex. Brown Incorporated.+
 4.3   Purchases Agreement dated as of June 10, 1999 between the
       Company and Deutsche Bank Securities, Inc.**
 4.4   Registration Rights Agreement dated as of October 16, 1997
       among the Company, and BT Alex. Brown Incorporated.+
 4.5   Registration Rights Agreement dated as of December 10, 1996
       by and among the Company, BRS and various investors, the
       Farallon Entities, CMC, and certain Town Sports
       stockholders.+
 4.6   Registration Rights Agreement dated as of June 21, 1999
       between Town Sports International, Inc., and Deutsche Bank
       Securities, Inc.**
 4.7   First Amendment to Registration Rights Agreement by and
       among the Company, BRS, CMC, Canterbury Detroit Partners
       L.P. "CDP", Rosewood Capital Partners L.P. "RC", the
       Farallon Entities and certain other stockholders of the
       Company, dated as of November 13, 1998.***
</TABLE>

                                        31
<PAGE>   34
<TABLE>
<C>    <S>
 4.8   Second Amendment to Registration Rights Agreement by and
       among the Company, BRS,        , CMC, CDP, RC, the Farallon
       Entities, CapitalSource Holdings LLC ("CapitalSource") and
       certain other stockholders of the Company, dated November 6,
       2000.
10.1   Amended and Restated Credit Agreement among the Company,
       Various Lending Institutions and Bankers Trust Company, as
       Administrative Agent dated as of October 16, 1997.+
10.2   First Amendment to the Amended and Restated Credit Agreement
       among the Company, Various Lending Institutions and Bankers
       Trust Company, as Administrative Agent dated as of August 6,
       1998.*
10.3   Second Amendment to the Amended and Restated Credit
       Agreement among the Company, Various Lending Institutions
       and Bankers Trust Company, as Administrative Agent dated as
       of January 28, 1999.****
10.4   Third Amendment to the Amended and Restated Credit
       Agreement, among the Company, Various Lending Institutions
       and Bankers Trust Company, as Administrative Agent, dated as
       of June 9, 1999.****
10.5   Fourth Amendment to the Amended and Restated Credit
       Agreement, among the Company, Various Lending Institutions
       and Bankers Trust Company as administrative Agent dated as
       of March 1, 2000.****
10.6   Fifth Amendment to the Amended and Restated Credit
       Agreement, among the Company, Various Lending Institutions
       and Bankers Trust Company, as Administrative Agent, dated as
       of November 3, 2000.
10.7   Subordinated Credit Agreement among the Company and
       CapitalSource dated November 6, 2000
10.8   Stock Purchase Agreement among the Company, CMC and CDP,
       dated as of November 13, 1998.***
10.9   Stock Purchase Agreement among the Company, the Farallon
       Entities and RC, dated as of November 30, 1998.***
10.10  Stock Purchase Agreement among the Company and CapitalSource
       dated as of November 6, 2000.
10.11  Shareholders' Agreement dated as of December 10, 1996 by and
       among the Company, BRS, the Farallon Entities, CMC and
       certain other stockholders of the Company.+
10.12  Amended and Restated Shareholders' Agreement among the
       Company, BRS, the Farallon Entities, RC, CMC, and CDP, dated
       as of November 13, 1998.***
21.1   Subsidiaries of the Company.
</TABLE>

---------------
   + Incorporated by reference to the Registrant's Registration Statement on
     Form S-4, File No. 333-40907.

   * Incorporated by reference to the Registrant's Registration Statement on
     Form S-1, File No. 333-61439.

  ** Incorporated by reference to the Registrant's Registration Statement on
     Form S-4, File No. 333-82607.

 *** Incorporated by reference to the Registrant's December 31, 1998 Form 10-K.

**** Incorporated by reference to the Registrant's December 31, 1999 Form 10-K.

                                        32
<PAGE>   35

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Town Sports International, Inc.:

     In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' deficit and cash
flows present fairly, in all material respects, the financial position of TOWN
SPORTS INTERNATIONAL, INC. and SUBSIDIARIES at December 31, 1999, and 2000, and
the results of their operations and their cash flows for the year ended May 31,
1998, for the seven months ended December 31, 1998 and for the years ended
December 31, 1999 and 2000, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

     As discussed in Note 2n to the consolidated financial statements, the
Company changed its method of accounting for organizational costs effective June
1, 1997.

/s/ PricewaterhouseCoopers LLP

February 15, 2001
New York, New York

                                       F-1
<PAGE>   36

                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                      ALL FIGURES $'000, EXCEPT SHARE DATA
                           DECEMBER 31, 1999 AND 2000

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1999        2000
                                                              --------    --------
<S>                                                           <C>         <C>
ASSETS
Current assets:
  Cash and cash equivalents.................................  $ 27,125    $  3,365
  Accounts receivable.......................................       576         678
  Inventory.................................................     1,070         893
  Prepaid corporate income taxes............................        --       1,828
  Prepaid expenses and other current assets.................     1,475       2,018
                                                              --------    --------
         Total current assets...............................    30,246       8,782
Fixed assets, net...........................................   123,894     161,510
Intangible assets, net......................................    37,648      55,399
Deferred tax asset..........................................    11,829      14,566
Deferred membership costs...................................    10,841      13,586
Other assets................................................     1,220       2,242
                                                              --------    --------
         Total assets.......................................  $215,678    $256,085
                                                              ========    ========
LIABILITIES, REDEEMABLE SENIOR PREFERRED STOCK AND
  STOCKHOLDERS' DEFICIT
Current liabilities:
  Current portion of long-term debt and capital lease
    obligations.............................................  $  2,276    $  3,411
  Accounts payable..........................................     3,146       2,550
  Accrued expenses..........................................     9,811      18,284
  Corporate income taxes payable............................       305          --
  Deferred revenue..........................................    15,723      22,951
                                                              --------    --------
         Total current liabilities..........................    31,261      47,196
Long-term debt and capital lease obligations................   129,926     141,087
Deferred lease liabilities..................................    13,852      17,044
Deferred revenue............................................     2,049       2,736
Other liabilities...........................................     2,121       3,904
                                                              --------    --------
         Total liabilities..................................   179,209     211,967
                                                              --------    --------
Commitments and contingencies
Redeemable senior preferred stock, $1.00 par value;
  liquidation value $45,478 and $51,100 at December 31, 1999
  and 2000, respectively; authorized 100,000 shares; 40,000
  shares issued and outstanding at December 31, 1999 and
  2000, respectively........................................    42,066      48,029
                                                              --------    --------
Stockholders' deficit:
  Series A preferred stock, at liquidation value............    23,216      26,580
  Series B preferred stock, at liquidation value............       204         232
  Class A voting common stock, $.001 par value; issued and
    outstanding 1,014,086 shares at December 31, 1999 and
    1,005,698 shares at December 31, 2000...................         1           1
  Paid-in capital...........................................     8,556      10,280
  Unearned compensation.....................................    (1,240)       (156)
  Foreign currency translation adjustment...................        --          12
  Accumulated deficit.......................................   (36,334)    (40,860)
                                                              --------    --------
         Total stockholders' deficit........................    (5,597)     (3,911)
                                                              ========    ========
         Total liabilities, redeemable senior preferred
          stock and stockholders' deficit...................  $215,678    $256,085
                                                              ========    ========
</TABLE>

                See notes to consolidated financial statements.
                                       F-2
<PAGE>   37

                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                               ALL FIGURES $'000
   FOR THE YEAR ENDED MAY 31, 1998, THE SEVEN MONTHS ENDED DECEMBER 31, 1997
      (UNAUDITED), AND 1998 AND THE YEARS ENDED DECEMBER 31, 1999 AND 2000

<TABLE>
<CAPTION>
                                     YEAR ENDED     {SEVEN MONTHS ENDED           YEAR ENDED
                                      MAY 31,           DECEMBER 31,             DECEMBER 31,
                                     ----------    ----------------------    --------------------
                                        1998          1997         1998        1999        2000
                                     ----------    -----------    -------    --------    --------
                                                   (UNAUDITED)
<S>                                  <C>           <C>            <C>        <C>         <C>
Revenues:
  Club operations..................   $79,719      $    41,490    $69,964    $157,440    $222,424
  Fees and other...................     2,631            1,500      1,698       2,339       2,625
                                      -------      -----------    -------    --------    --------
                                       82,350           42,990     71,662     159,779     225,049
                                      -------      -----------    -------    --------    --------
Operating expenses:
  Payroll and related..............    33,309           17,621     28,001      62,412      89,677
  Club operating...................    25,858           13,258     24,261      52,619      69,390
  General and administrative.......     5,825            2,742      5,828      10,908      14,754
  Depreciation and amortization....     7,736            3,944      8,818      20,935      26,642
  Compensation expense incurred in
     connection with stock
     options.......................     1,442              397        434       2,042       1,836
                                      -------      -----------    -------    --------    --------
                                       74,170           37,962     67,342     148,916     202,299
                                      -------      -----------    -------    --------    --------
     OPERATING INCOME..............     8,180            5,028      4,320      10,863      22,750
Interest expense, net of interest
  income of $1,228, $526, $272,
  $1,284 and $1,180,
  respectively.....................     5,902            3,270      5,279      10,243      13,120
                                      -------      -----------    -------    --------    --------
     INCOME (LOSS) BEFORE PROVISION
       (BENEFIT) FOR CORPORATE
       INCOME TAXES................     2,278            1,758       (959)        620       9,630
Provision (benefit) for corporate
  income taxes.....................     1,131              888       (399)        571       4,799
                                      -------      -----------    -------    --------    --------
     INCOME (LOSS) BEFORE
       EXTRAORDINARY ITEM AND
       CUMULATIVE EFFECT OF CHANGE
       IN ACCOUNTING POLICY........     1,147              870       (560)         49       4,831
Extraordinary loss from early
  extinguishment of debt, net of
  income tax benefit of $624.......      (782)            (782)        --          --          --
                                      -------      -----------    -------    --------    --------
     INCOME (LOSS) BEFORE
       CUMULATIVE EFFECT OF CHANGE
       IN ACCOUNTING POLICY........       365               88       (560)         49       4,831
Cumulative effect on prior years of
  a change in accounting for club
  organizational costs, net of
  income tax benefit of $70........       (88)             (88)        --          --          --
                                      -------      -----------    -------    --------    --------
     NET INCOME (LOSS).............       277               --       (560)         49       4,831
Accreted dividends on preferred
  stock............................    (2,387)          (1,485)    (2,146)     (7,880)     (9,016)
                                      -------      -----------    -------    --------    --------
     NET LOSS ATTRIBUTABLE TO
       COMMON STOCKHOLDERS.........   $(2,110)     $    (1,485)   $(2,706)   $ (7,831)   $ (4,185)
                                      =======      ===========    =======    ========    ========
</TABLE>

                See notes to consolidated financial statements.
                                       F-3
<PAGE>   38

                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
                      ALL FIGURES $'000, EXCEPT SHARE DATA
   FOR THE YEAR ENDED MAY 31, 1998, THE SEVEN MONTHS ENDED DECEMBER 31, 1998,
                 AND THE YEARS ENDED DECEMBER 31, 1999 AND 2000
<TABLE>
<CAPTION>
                                               PREFERRED STOCK                COMMON STOCK
                                     -----------------------------------   ------------------
                                         SERIES A           SERIES B            CLASS A
                                        ($1.00 PAR)        ($1.00 PAR)        ($.001 PAR)
                                     -----------------   ---------------   ------------------   PAID-IN     UNEARNED
                                     SHARES    AMOUNT    SHARES   AMOUNT    SHARES     AMOUNT   CAPITAL   COMPENSATION
                                     -------   -------   ------   ------   ---------   ------   -------   ------------
<S>                                  <C>       <C>       <C>      <C>      <C>         <C>      <C>       <C>
    Balance at June 1, 1997........  152,455   $16,250    3,857    $144    1,010,000     $1          --
Issuance of Series A Preferred
  Stock and Class A Common Stock...    1,182       119                         5,714     --     $     6
Unearned Compensation incurred in
  connection with common stock
  options..........................                                                               3,352     $(3,352)
Amortization of unearned
  compensation.....................                                                                             806
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                                                 636
Accretion of Series A and Series B
  preferred stock dividend ($15.14
  and $5.44 per share,
  respectively)....................              2,367               20
Net income.........................
                                     -------   -------   ------    ----    ---------     --     -------     -------
    Balance at May 31, 1998........  153,637    18,736    3,857     164    1,015,714      1       3,994      (2,546)
Warrant issuance in connection with
  Redeemable Senior Preferred
  Stock............................                                                               3,416
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                                                 434
Accretion of Series A and Series B
  preferred stock dividend ($10.51
  and $3.89 per share,
  respectively)....................              1,615               15
Accretion of redeemable senior
  preferred stock dividend ($12.20
  per share plus accretion to
  liquidation value)...............
Net loss...........................
                                     -------   -------   ------    ----    ---------     --     -------     -------
    Balance at December 31, 1998...  153,637    20,351    3,857     179    1,015,714      1       7,844      (2,546)
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                                                 784
Amortization of unearned
  compensation.....................                                                                           1,258
Accretion of Series A and Series B
  preferred stock dividend ($18.64
  and $6.48 per share,
  respectively)....................              2,865               25
Accretion of redeemable senior
  preferred stock dividend ($124.75
  per share plus accretion to
  liquidation value)...............
Cancellation of unvested options...                                                                 (48)         48
Repurchase of shares...............                          (2)     --       (1,628)    --         (24)
Net income.........................
                                     -------   -------   ------    ----    ---------     --     -------     -------
    Balance at December 31, 1999...  153,637    23,216    3,855     204    1,014,086      1       8,556      (1,240)
Stock commitment in connection with
  subordinated credit facility.....                                                               1,360
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                                                 867
Amortization of unearned
  compensation.....................                                                                             969
Accretion of Series A and Series B
  preferred stock dividend ($21.90
  and $7.85 per share,
  respectively)....................              3,364               30
Accretion of redeemable senior
  preferred stock dividend ($140.55
  per share plus accretion to
  liquidation value)...............
Cancellation of unvested options...                                                                (115)        115
Exercise of stock options..........                       5,384                3,757                 61
Repurchase of shares...............                      (5,417)     (2)     (12,145)              (449)
Foreign currency translation
  adjustment.......................
Net income.........................
                                     -------   -------   ------    ----    ---------     --     -------     -------
    Balance at December 31, 2000...  153,637   $26,580    3,822    $232    1,005,698     $1     $10,280     $  (156)
                                     =======   =======   ======    ====    =========     ==     =======     =======

<CAPTION>

                                       FOREIGN
                                      CURRENCY                       TOTAL
                                     TRANSLATION   ACCUMULATED   STOCKHOLDERS'
                                     ADJUSTMENT      DEFICIT        DEFICIT
                                     -----------   -----------   -------------
<S>                                  <C>           <C>           <C>
    Balance at June 1, 1997........                 $(23,346)       $(6,951)
Issuance of Series A Preferred
  Stock and Class A Common Stock...                                     125
Unearned Compensation incurred in
  connection with common stock
  options..........................
Amortization of unearned
  compensation.....................                                     806
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                     636
Accretion of Series A and Series B
  preferred stock dividend ($15.14
  and $5.44 per share,
  respectively)....................                   (2,387)
Net income.........................                      277            277
                                         ---        --------        -------
    Balance at May 31, 1998........                  (25,456)        (5,107)
Warrant issuance in connection with
  Redeemable Senior Preferred
  Stock............................                                   3,416
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                     434
Accretion of Series A and Series B
  preferred stock dividend ($10.51
  and $3.89 per share,
  respectively)....................                   (1,630)
Accretion of redeemable senior
  preferred stock dividend ($12.20
  per share plus accretion to
  liquidation value)...............                     (516)          (516)
Net loss...........................                     (560)          (560)
                                         ---        --------        -------
    Balance at December 31, 1998...                  (28,162)        (2,333)
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                     784
Amortization of unearned
  compensation.....................                                   1,258
Accretion of Series A and Series B
  preferred stock dividend ($18.64
  and $6.48 per share,
  respectively)....................                   (2,890)            --
Accretion of redeemable senior
  preferred stock dividend ($124.75
  per share plus accretion to
  liquidation value)...............                   (5,331)        (5,331)
Cancellation of unvested options...
Repurchase of shares...............                                     (24)
Net income.........................                       49             49
                                         ---        --------        -------
    Balance at December 31, 1999...                  (36,334)        (5,597)
Stock commitment in connection with
  subordinated credit facility.....                                   1,360
Compensation expense incurred in
  connection with Series B
  Preferred stock options..........                                     867
Amortization of unearned
  compensation.....................                                     969
Accretion of Series A and Series B
  preferred stock dividend ($21.90
  and $7.85 per share,
  respectively)....................                   (3,394)            --
Accretion of redeemable senior
  preferred stock dividend ($140.55
  per share plus accretion to
  liquidation value)...............                   (5,963)        (5,963)
Cancellation of unvested options...                                      --
Exercise of stock options..........                                      61
Repurchase of shares...............                                    (451)
Foreign currency translation
  adjustment.......................      $12              --             12
Net income.........................                    4,831          4,831
                                         ---        --------        -------
    Balance at December 31, 2000...      $12        $(40,860)       $(3,911)
                                         ===        ========        =======
</TABLE>

                See notes to consolidated financial statements.
                                       F-4
<PAGE>   39

                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                               ALL FIGURES $'000
   FOR THE YEAR ENDED MAY 31, 1998, THE SEVEN MONTHS ENDED DECEMBER 31, 1997,
      (UNAUDITED) AND 1998 AND THE YEARS ENDED DECEMBER 31, 1999 AND 2000
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
                                                          YEAR ENDED     SEVEN MONTHS ENDED         YEAR ENDED
                                                           MAY 31,          DECEMBER 31,           DECEMBER 31,
                                                          ----------   ----------------------   -------------------
                                                             1998         1997         1998       1999       2000
                                                          ----------   -----------   --------   --------   --------
                                                                       (UNAUDITED)
<S>                                                       <C>          <C>           <C>        <C>        <C>
Cash flows from operating activities:
  Net income (loss).....................................   $    277     $     --     $   (560)  $     49   $  4,831
                                                           --------     --------     --------   --------   --------
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
    Compensation expense incurred in connection with
      stock options.....................................      1,442          397          434      2,042      1,836
    Depreciation and amortization.......................      7,736        3,944        8,818     20,935     26,642
    Amortization of debt issuance costs.................        412          245          363      1,147      1,531
    Losses from extinguishment of debt..................      1,406        1,377           --         --         --
    Write-off of organization costs.....................        158          158           --         --         --
    Noncash rental expense, net of noncash rental
      income............................................      2,670        1,354        1,493      3,061      2,976
    Net change in certain working capital components....      4,316        1,620          204      9,596      9,392
    Increase in deferred tax asset......................     (1,187)      (1,081)      (1,411)    (3,259)    (3,326)
    Increase in deferred membership costs...............     (1,403)        (708)      (2,072)    (3,836)    (2,745)
    Other...............................................        (94)        (113)         124       (239)      (564)
                                                           --------     --------     --------   --------   --------
         TOTAL ADJUSTMENTS..............................     15,456        7,193        7,953     29,447     35,742
                                                           --------     --------     --------   --------   --------
         NET CASH PROVIDED BY OPERATING ACTIVITIES......     15,733        7,193        7,393     29,496     40,573
                                                           --------     --------     --------   --------   --------
Cash flows from investing activities:
  Capital expenditures, net of effect of acquired
    businesses..........................................    (16,170)      (5,304)     (21,815)   (53,364)   (47,454)
  Acquisition of businesses, net of cash acquired.......    (19,733)      (7,058)     (25,103)    (2,932)   (24,053)
  Investment in affiliate...............................         --           --           --         --       (210)
  Intangible and other assets...........................       (137)          --         (434)       (33)      (359)
  Landlord contributions................................         --           --           --      1,251      2,028
                                                           --------     --------     --------   --------   --------
         NET CASH USED IN INVESTING ACTIVITIES..........    (36,040)     (12,362)     (47,352)   (55,078)   (70,048)
                                                           --------     --------     --------   --------   --------
Cash flows from financing activities:
  Issuance of stock, net of expenses....................        125          125           --         --         --
  Issuance of Senior Preferred Stock, net of expenses...         --           --       39,635         --         --
  Redemption and liquidation of stock, including
    expenses............................................         --           --           --        (24)      (390)
  Proceeds from borrowings, net of expenses.............     85,841       85,570       16,975     35,581     10,303
  Repayments of borrowings..............................    (45,130)     (43,334)     (20,494)    (2,004)    (4,198)
                                                           --------     --------     --------   --------   --------
         NET CASH PROVIDED BY FINANCING ACTIVITIES......     40,836       42,361       36,116     33,553      5,715
                                                           --------     --------     --------   --------   --------
         NET INCREASE (DECREASE) IN CASH AND CASH
           EQUIVALENTS..................................     20,529       37,192       (3,843)     7,971    (23,760)
Cash and cash equivalents at beginning of period........      2,468        2,468       22,997     19,154     27,125
                                                           --------     --------     --------   --------   --------
         CASH AND CASH EQUIVALENTS AT END OF PERIOD.....   $ 22,997     $ 39,660     $ 19,154   $ 27,125   $  3,365
                                                           ========     ========     ========   ========   ========
Summary of the change in certain working capital
  components, net of effects of acquired businesses:
  (Increase) decrease in accounts receivable............   $   (108)    $     69     $   (208)  $    272   $    151
  (Increase) decrease in inventory......................       (343)        (323)        (580)       183        213
  (Increase) decrease in prepaid expenses and other
    current assets......................................         30          (18)        (336)        43        392
  Increase (decrease) in accounts payable and accrued
    expenses............................................      1,895          981       (2,330)     3,022      4,990
  (Increase) decrease in prepaid corporate income
    taxes...............................................        324           --           --        243       (624)
  Increase in deferred revenue..........................      2,518          911        3,658      5,833      4,270
                                                           --------     --------     --------   --------   --------
         NET CHANGE IN CERTAIN WORKING CAPITAL
           COMPONENTS...................................   $  4,316     $  1,620     $    204   $  9,596   $  9,392
                                                           ========     ========     ========   ========   ========
</TABLE>

                See notes to consolidated financial statements.

                                       F-5
<PAGE>   40

                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                      ALL FIGURES $'000, EXCEPT SHARE DATA

1. NATURE OF BUSINESS

     Town Sports International, Inc. and Subsidiaries (the "Company") owns and
operates 103 fitness clubs ("clubs") and partly owns and operates two clubs. The
Company operates 70 clubs in the New York metropolitan market, 15 clubs in the
Boston market, 13 clubs in the Washington, D.C. market, five in the Philadelphia
market and two clubs in Switzerland as of December 31, 2000. The Company's
geographic concentration in the New York metropolitan market may expose the
Company to adverse developments related to competition, demographic changes,
real estate costs and economic down turns. The Company operates in a single
segment. The Company's overseas operations are immaterial to the Company's
financial position, results of operations, and cash flows.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  a. Principles of Consolidation

     The accompanying consolidated financial statements include the accounts of
Town Sports International, Inc. and all wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

  b. Change in Year End

     On January 7, 1999, the Company's board of directors approved a change in
the Company's fiscal year end from May 31 to December 31, effective beginning
with the seven month period ended December 31, 1998 ("the transition period").

  c.  Revenue Recognition

     The Company receives a one-time non-refundable initiation fee and monthly
dues from its members. Substantially all of the Company's members join on a
month-to-month basis and can therefore cancel their membership at any time with
30 days notice. Initiation fees and related direct expenses, primarily salaries
and sales commissions payable to membership consultants, are deferred and
recognized, on a straight-line basis, in operations over an estimated membership
life of twenty four (24) months. Dues that are received in advance are
recognized on a pro-rata basis over the periods in which services are to be
provided. Management fees earned for services rendered are recognized at the
time the related services are performed.

     The Company recognizes revenue from merchandise sales upon delivery to the
member.

     In connection with advance receipts of fees or dues, the Company is
required to maintain surety bonds totaling $2,800 pursuant to various state
consumer protection laws.

  d. Inventory

     Inventory consists of athletic equipment, supplies and clothing for sale to
members and club supplies. Inventories are valued at the lower of cost or market
by the first-in, first-out method.

  e. Fixed Assets

     Fixed assets are recorded at cost and depreciated on a straight-line basis
over the estimated useful lives of the assets, which are thirty years for
building and improvements, five years for club equipment, furniture, fixtures
and computer equipment, and three years for computer software. Leasehold
improvements are amortized over the shorter of their estimated useful lives or
the remaining period of the lease. Expenditures for maintenance and repairs are
charged to operations as incurred. The cost and related accumulated depreciation

                                       F-6
<PAGE>   41
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

or amortization of assets retired or sold are removed from the respective
accounts and any gain or loss is recognized in operations.

  f. Advertising and Club Preopening Costs

     Advertising costs and club preopening costs are charged to operations
during the period in which they are incurred except for production costs related
to television and radio advertisements which are expensed when the related
commercials are aired. Total advertising costs incurred by the Company during
the year ended May 31, 1998, the seven months ended December 31, 1998, the year
ended December 31, 1999 and 2000 totaled $2,147, $2,081, $5,024 and $7,484,
respectively.

  g. Use of Estimates

     The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates.

     The most significant assumptions and estimates relate to the useful lives
and recoverability of fixed and intangible assets, deferred income tax
valuation, valuation of and expense incurred in connection with stock options
and warrants, legal contingencies and the estimated membership life.

  h. Corporate Income Taxes

     Deferred tax liabilities and assets are recognized for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred tax liabilities and assets are
determined on the basis of the difference between the financial statement and
tax bases of assets and liabilities ("temporary differences") at enacted tax
rates in effect for the years in which the temporary differences are expected to
reverse. A valuation allowance is recorded to reduce deferred tax assets to the
amount that is more likely than not to be realized.

  i. Statements of Cash Flows

     Supplemental disclosure of cash flow information:

<TABLE>
<CAPTION>
                                                       SEVEN MONTHS ENDED          YEAR ENDED
                                        YEAR ENDED        DECEMBER 31,            DECEMBER 31,
                                         MAY 31,      ---------------------    ------------------
                                           1998          1997         1998      1999       2000
                                        ----------    -----------    ------    -------    -------
                                                      (UNAUDITED)
<S>                                     <C>           <C>            <C>       <C>        <C>
Cash paid:
  Interest (net of amounts
     capitalized).....................    $6,978        $2,430       $4,705    $10,083    $13,926
  Taxes...............................     1,300           455        1,072      3,577      9,054
Noncash investing and financing
  activities:
  Acquisition of fixed assets included
     in accounts payable..............     2,496            99        1,394      2,859      3,757
  Acquisition of equipment and
     software financed by lessors.....       562           261           --      3,386      3,951
See Notes 6, 9 and 10 for additional
  noncash investing and financing
  activities
</TABLE>

                                       F-7
<PAGE>   42
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  j. Cash and Cash Equivalents

     The Company considers all highly liquid debt instruments which have
original maturities of three months or less when acquired to be cash
equivalents. The carrying amounts reported in the balance sheets for cash and
cash equivalents approximate fair value.

  k. Deferred Lease Liabilities and Noncash Rental Expense

     The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis over the life of the lease.

  l. Foreign Currency

     Transactions denominated in a foreign currency have been translated into
U.S. dollars at the rates of exchange at the transaction dates. Assets and
liabilities have been translated at the respective year-end exchange rates. For
all periods presented foreign exchange gains and losses were not material.

     In March 2000 the Company acquired the two Swiss clubs that were previously
managed by the Company. These clubs use the local currency as their functional
currency and, accordingly, their assets and liabilities are translated into U.S.
dollars at year-end exchange rates while their income and expense items are
translated into U.S. dollars at the average exchange rate for the period.
Adjustments resulting from foreign functional currency financial statements into
U.S. dollars are included in the currency translation adjustment in
stockholders' deficit. Comprehensive income represents changes to stockholders'
deficit except those resulting from investments from, and distributions to,
stockholders. The difference between the Company's net income and comprehensive
income is the effect of foreign exchange translation adjustments which is
immaterial for all periods presented.

  m. Investments in Affiliated Companies

     The Company has investments in Capitol Hill Squash Club Associates and
Kalorama Sports Management Associates (collectively referred to as the
"Affiliates"). The Affiliates have operations, which are similar, or related to,
those of the Company. The Company accounts for these Affiliates in accordance
with the equity method. The assets, liabilities, equity and operating results of
the Affiliates and the Company's pro rata share of the Affiliates' net assets
and operating results were not material for all periods presented.

  n. Intangible Assets

     Intangible assets consist of membership lists, debt issuance costs,
goodwill and covenants-not-to-compete. Such intangibles are stated at cost and,
except debt issuance costs, are being amortized by the straight-line method over
their estimated lives. Debt issuance costs are amortized as additional interest
expense over the life of the underlying debt, four to seven years, using the
interest method. Membership lists are amortized over 24 months, goodwill is
being amortized over the remaining lives of the underlying club leases, five to
fifteen years, and covenants not-to-compete are amortized over the contractual
life, generally five years.

     Prior to the year ended May 31, 1998, the Company capitalized direct costs
(legal fees and real-estate commissions) incurred to obtain leases for new clubs
to be constructed by the Company ("Organizational Costs"). Such amounts were
amortized over a five year period using the straight-line method. During the
quarter ended May 31, 1998, the Company adopted the provisions of Statement of
Position 98-5 Reporting on the costs of start-up activities ("SOP 98-5") which
requires that Organizational Costs be expensed as incurred. In connection with
the adoption of SOP 98-5, the Company recorded a pre-tax charge of $158, $88 net
of taxes, as the cumulative effect of this accounting change.

                                       F-8
<PAGE>   43
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  o. Accounting for the Impairment of Long-Lived Assets

     Long-lived assets, such as fixed assets and intangible assets, including
goodwill, are reviewed for impairment when events or circumstances indicate that
their carrying value may not be recoverable. Estimated undiscounted expected
future cash flows are used to determine if an asset is impaired in which case
the asset's carrying value would be reduced to fair value. For all periods
presented, no impairment losses were recorded.

  p. Concentrations of Credit Risk

     Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts are
held, primarily, in a single commercial bank. The Company holds no collateral
for these financial instruments.

  q. Stock-Based Employee Compensation

     For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method ("APB No. 25"). In
accordance with this method, no compensation expense is recognized in the
accompanying financial statements in connection with the awarding of stock
option grants to employees provided that, as of the grant date, all terms
associated with the award are fixed and the fair value of the Company's stock is
not greater than the amount an employee must pay to acquire the stock as
defined; however, to the extent that stock options are granted to employees with
variable terms or if the fair value of the Company's stock as of the measurement
date is greater than the amount an employee must pay to acquire the stock, then
the Company will recognize compensation expense. The fair value of options or
warrants granted to nonemployees for financing are included in operating results
as an expense.

     Disclosures, including pro forma operating results had the Company prepared
its financial statements in accordance with the fair value based method of
accounting for stock-based compensation, have been included in Note 9.

  r. Other Recent Accounting Pronouncements

     Management believes the future adoption of recently issued accounting
standards will not have a material impact on the Company's financial statements.

  s. Unaudited Financial Information for the seven months ended December 31,
1997

     The unaudited financial information for the seven months ended December 31,
1997 reflects all adjustments which, in the opinion of management, are necessary
for a fair presentation of the financial position and results of operations. All
such adjustments are of a normal and recurring nature.

                                       F-9
<PAGE>   44
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. FIXED ASSETS

     Fixed assets as of December 31, 1999 and 2000, are shown at cost, less
accumulated depreciation and amortization, and are summarized below:

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1999        2000
                                                              --------    --------
<S>                                                           <C>         <C>
Leasehold improvements......................................  $ 98,567    $139,039
Club equipment..............................................    29,543      38,141
Furniture, fixtures and computer equipment..................    17,395      24,871
Building and improvements...................................     4,995       4,995
Land........................................................       986         986
Construction in progress....................................     8,796       7,624
                                                              --------    --------
                                                               160,282     215,656
  Less, Accumulated depreciation and amortization...........    36,388      54,146
                                                              --------    --------
                                                              $123,894    $161,510
                                                              ========    ========
</TABLE>

     Depreciation and leasehold amortization expense for the year ended May 31,
1998, the seven months ended December 31, 1998, and the years ended December 31,
1999 and 2000, was $6,130, $5,664, $15,056 and $20,706, respectively.

4. INTANGIBLE ASSETS

     Intangible assets as of December 31, 1999 and 2000 are shown at cost, less
accumulated amortization, and are summarized below:

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1999       2000
                                                              -------    -------
<S>                                                           <C>        <C>
Goodwill arising on acquisition of businesses...............  $34,682    $54,609
Membership lists............................................    6,024      9,572
Debt issuance costs.........................................    8,630     10,350
Covenants-not-to-compete....................................    1,251      1,276
                                                              -------    -------
                                                               50,587     75,807
  Less, Accumulated amortization............................   12,939     20,408
                                                              -------    -------
                                                              $37,648    $55,399
                                                              =======    =======
</TABLE>

     Amortization expense of intangible assets for the year ended May 31, 1998,
the seven months ended December 31, 1998 and the years ended December 31, 1999
and 2000, was $2,018, $3,517, $7,026 and $7,467, respectively. Such amount
include amortization expense of debt issuance costs of $412, $363, $1,147 and
$1,531 respectively, which has been classified as interest expense for financial
reporting purposes.

     Goodwill amortization for the year ended May 31, 1998, the seven months
ended December 31, 1998 and the years ended December 31, 1999 and 2000 was $843,
$1,512, $2,845 and $3,545, respectively.

                                       F-10
<PAGE>   45
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. ACCRUED EXPENSES

     Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1999      2000
                                                              ------    -------
<S>                                                           <C>       <C>
Accrued payroll.............................................  $4,389    $ 9,196
Accrued interest............................................   2,773      2,276
Accrued construction in progress and equipment..............   1,358      3,583
Accrued other...............................................   1,291      3,229
                                                              ------    -------
                                                              $9,811    $18,284
                                                              ======    =======
</TABLE>

6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

     Long-term debt and capital lease obligations consist of the following:

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1999        2000
                                                              --------    --------
<S>                                                           <C>         <C>
Series B-9 3/4% Senior Notes, due 2004......................  $125,000    $125,000
Line of credit line borrowings..............................        --       9,000
Notes payable for acquired businesses.......................     3,777       4,129
Capital lease obligations...................................     3,425       6,369
                                                              --------    --------
                                                               132,202     144,498
  Less, Current portion due within one year.................     2,276       3,411
                                                              --------    --------
     Long-term portion......................................  $129,926    $141,087
                                                              ========    ========
</TABLE>

     The aggregate long-term debt and capital lease obligations maturing during
the next five years and thereafter is as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,                                   AMOUNT DUE
------------------------                                   ----------
<S>                                                        <C>
2001.....................................................   $  3,411
2002.....................................................     11,806
2003.....................................................      2,772
2004.....................................................    126,184
2005.....................................................        139
Thereafter...............................................        186
                                                            --------
                                                            $144,498
                                                            ========
</TABLE>

     In October 1997, the Company issued $85,000 of Series B 9 3/4% Senior Notes
("Senior Notes"), due October 2004. The net proceeds from the Senior Notes
totaled approximately $81,700. The transaction fees of approximately $3,300,
were accounted for as deferred financing costs. In June 1999, the Company issued
$40,000 of Senior Notes at a price of 98.75%, providing the Company with $39,500
of proceeds before expenses relating to the issuance. The transaction fees of
approximately $3,900 and were accounted for as deferred financing costs. The
Senior Notes bear interest at an annual rate of 9 3/4%, payable semi-annually.
The Senior Notes are redeemable at the option of the Company on or after October
15, 2001. For redemption prior to October 15, 2004, the Company would be
required to pay a premium as defined. The Senior Notes are non-collateralized
and rank "pari passu" with all unsubordinated debt and senior in right of
payment with all subordinated indebtedness of the Company. The note indenture
under which the Senior Notes were issued

                                       F-11
<PAGE>   46
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

contains certain covenants that, among other things, limit the Company's ability
to incur additional indebtedness, pay dividends or make certain other restricted
payments, engage in transactions with affiliates, incur liens and engage in
asset sales.

     The Company has a line of credit with its principal bank for direct
borrowings and letters of credit of up to $25,000. The line of credit carries
interest at the Company's option based upon the Eurodollar borrowing rate plus
2.50% or the bank's prime rate plus 1.50%, as defined and the Company is
required to pay a commitment commission of 0.375% per annum based upon the daily
unutilized amount. There were $6,000 of Eurodollar borrowings and $3,000 of
prime rate borrowings outstanding against this line as of December 31, 2000. The
amount available for borrowing has been further reduced by outstanding letters
of credit totaling $1,765 (see Note 8). The interest rates charded on the
Eurodollar and prime rate borrowings outstanding at December 31, 2000 were 9.18%
and 11.00%, respectively. This line of credit expires on October 15, 2002. The
line, as amended, contains various covenants including interest coverage and a
leverage ratio as well as restrictions on the payment of dividends. The line is
collateralized by a mortgage on land, building and equipment, which, as of
December 31, 2000, had an aggregate book value of approximately $3,865, and by
all other assets of the Company.

     In November 2000 the Company entered into a Subordinated Credit Agreement
(the "Agreement") with an affiliate of a stockholder of the Company. This
Agreement provides for up to $20,000 of principal borrowings and expires
December 31, 2004. Interest on principal borrowings accrues at 13% per annum;
10% of which is payable on a monthly basis and the remaining 3% is accruable, at
the option of the Company, through maturity. The total amount of accrued and
unpaid interest may not exceed $2,500. The Company is charged a fee of 0.083%
per month based on the portion of the facility not utilized. In connection with
this agreement the Company paid a commitment fee of $225 to the lender,
approximately $73 of legal fees, and committed to issue 16,000 shares of common
stock to the lender. The commitment to issue common stock is at the earlier of
the Company's initial borrowing under the Agreement or its termination. The
estimated fair value of these shares of common stock of $1,360 and the
aforementioned commitment and legal fees were accounted for as deferred
financing costs. In addition, the Company has agreed to issue an additional
7,000 shares of common stock to the lender in the event that the agreement has
not been terminated prior to November 30, 2002. The Agreement contains similar,
but less restrictive covenants than those with the line of credit, as amended.

     Notes payable were incurred upon the acquisition of various clubs and are
subject to the Company's right of offset for possible post acquisition
adjustments arising out of operations of the acquired clubs. These notes are
stated at a discount from face value at rates of between 5% and 9%, and are
non-collateralized.

     The carrying value of long-term debt, other than the Senior Notes,
approximates fair market value as of December 31, 1999 and 2000 as the debt is
generally short-term in nature. The Senior Notes have a fair value of
approximately $117,500, based on the quoted market price as of December 31,
2000.

     The Company's interest expense and capitalized interest related to funds
borrowed to finance club facilities under construction for the year ended May
31, 1998, the seven months ended December 31, 1998 and the years ended December
31, 1999 and 2000 are as follows:

<TABLE>
<CAPTION>
                                                        SEVEN
                                                        MONTHS
                                       YEAR ENDED       ENDED        YEARS ENDED DECEMBER 31,
                                        MAY 31,      DECEMBER 31,    ------------------------
                                          1998           1998          1999           2000
                                       ----------    ------------    ---------      ---------
<S>                                    <C>           <C>             <C>            <C>
Interest costs expensed..............    $7,130         $5,551        $11,527        $14,300
Interest costs capitalized...........       526            308            455            660
                                         ------         ------        -------        -------
                                         $7,656         $5,859        $11,982        $14,960
                                         ======         ======        =======        =======
</TABLE>

                                       F-12
<PAGE>   47
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The Company leases equipment under noncancelable capital leases. The
initial lease terms range from three to five years, after which the Company has
the right to purchase the equipment at amounts defined by the agreements.

     As of December 31, 2000, minimum rental payments, under all capital leases,
including payments to acquire leased equipment, are as follows:

<TABLE>
<CAPTION>
                                                             MINIMUM
YEAR ENDING DECEMBER 31,                                  ANNUAL RENTAL
------------------------                                  -------------
<S>                                                       <C>
2001....................................................     $2,405
2002....................................................      2,372
2003....................................................      2,082
2004....................................................        973
                                                             ------
                                                              7,832
  Less, Amounts representing interest...................      1,463
                                                             ------
     Present value of minimum capital lease payments....     $6,369
                                                             ======
</TABLE>

     The cost of leased equipment included in club equipment was approximately
$8,419 and $8,921 at December 31, 1999 and 2000, respectively; and the related
accumulated depreciation was $4,110 and $3,072, respectively.

7. RELATED PARTY TRANSACTIONS

     The Company entered into a professional service agreement with Bruckmann,
Rosser, Sherrill & Co., Inc. ("BRS"), a stockholder of the Company for strategic
and financial advisory services on December 10, 1996. Fees for such services are
$250 per annum, and are payable while BRS owns 20% or more of the outstanding
Common stock of the Company. No amounts were due BRS at December 31, 1998, 1999
and 2000.

8. LEASES

     The Company leases office, warehouse and multi-recreational facilities and
certain equipment under noncancelable operating leases. In addition to base
rent, the facility leases generally provide for additional rent based on
increases in real estate taxes and other costs. Certain leases give the Company
the right to acquire the leased facility at defined prices based on fair value
and provide for additional rent based upon defined formulas of revenue, cash
flow or operating results of the respective facilities. Under the provisions of
certain of these leases, the Company is required to maintain irrevocable letters
of credit, which total $1,765 as of December 31, 2000.

     The leases expire at various times through December 31, 2021, and certain
leases may be extended at the Company's option.

                                       F-13
<PAGE>   48
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Future minimum rental payments under noncancelable operating leases are as
follows:

<TABLE>
<CAPTION>
                                                             MINIMUM
YEAR ENDING DECEMBER 31,                                  ANNUAL RENTAL
------------------------                                  -------------
<S>                                                       <C>
2001....................................................    $ 33,161
2002....................................................      34,617
2003....................................................      34,209
2004....................................................      34,022
2005....................................................      33,122
Aggregate thereafter....................................     259,743
                                                            --------
                                                            $428,874
                                                            ========
</TABLE>

     Rent expense, including the effect of deferred lease liabilities, for the
year ended May 31, 1998, the seven months ended December 31, 1998 and the years
ended December 31, 1999 and 2000 was approximately $15,493, $13,914, $30,325,
and $37,268 respectively. Such amounts include additional rent of $2,590,
$2,087, $4,634 and $5,816, respectively.

     The Company, as landlord, leases space under noncancelable operating
leases. In addition to base rent, certain leases provide for additional rent
based on increases in real estate taxes, indexation, utilities and defined
amounts based on the operating results of the lessee. The leases expire at
various times through December 31, 2013. Future minimum rentals receivable under
noncancelable leases are as follows:

<TABLE>
<CAPTION>
                                                             MINIMUM
YEAR ENDING DECEMBER 31,                                  ANNUAL RENTAL
------------------------                                  -------------
<S>                                                       <C>
2001....................................................     $1,197
2002....................................................      1,113
2003....................................................        919
2004....................................................        522
2005....................................................        222
Aggregate thereafter....................................        336
                                                             ------
                                                             $4,309
                                                             ======
</TABLE>

     Rental income, including noncash rental income, for the year ended May 31,
1998, the seven months ended December 31, 1998, and the years ended December 31,
1999 and 2000, was approximately $963, $822, $1,529 and $1,716, respectively.
Such amounts included additional rental charges above the base rent of $651,
$608, $431 and $630, respectively.

9. STOCKHOLDERS' EQUITY AND REDEEMABLE SENIOR PREFERRED STOCK

  a. Capitalization

     The Company's certificate of incorporation, as amended, provides for the
issuance of up to 3,500,000 shares of capital stock, consisting of 2,500,000
shares of Class A Voting Common Stock ("Class A"), par value $0.001 per share;
500,000 shares of Class B Non-voting Common Stock ("Class B"), par value of
$0.001 per share, (Class A and Class B are collectively referred to herein as
"Common Stock"); 100,000 shares of Redeemable Senior Preferred Stock ("Senior"),
par value $1.00 per share; 200,000 shares of Series A Preferred Stock, ("Series
A") par value $1.00 per share, and 200,000 shares of Series B Preferred Stock
("Series B") par value $1.00 per share.

     All stockholders have preemptive rights to purchase a pro-rata share of any
future sales of securities, as defined.

                                       F-14
<PAGE>   49
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Redeemable Senior Preferred Stock

     During November 1998, the Company issued 40,000 shares of mandatorily
redeemable Senior stock and 143,261 warrants. The Senior stock has no voting
rights except as required by law. The warrants have an exercise price of $0.01,
expire in November 2008 and are exercisable into an equal number of shares of
Class A Common Stock. After payment of fees and expenses of approximately $365
the Company received net proceeds of $39,635. Upon issuance, a $3,416 value was
ascribed to the warrants. The initial fair value of the Senior stock ($36,219)
is being accreted to its liquidation value using the interest method. The
accreted amount for the seven months ended December 31, 1998 and the years ended
December 31, 1999 and 2000 was $28, $341 and $341, respectively. The Senior
stock is redeemable in November 2008. In the event that certain defined events
occur, the number of warrants exercisable will be reduced.

     The Senior stock has liquidation preferences over Series A, Series B and
Common Stock. The Senior stock may, at the option of the holder, be converted
into Common Stock upon the initial public offering ("IPO") of the Company's
common stock at a conversion rate equal to the IPO price.

     The Senior stock has a liquidation value of $1,000 per share plus
cumulative unpaid dividends of $11,100, as of December 31, 2000. The Senior
stockholders are entitled to a cumulative 12% annual dividend, based upon the
per share price of $1,000.

     A summary of transactions related to the Senior stock is as follows:

<TABLE>
<S>                                                           <C>
Proceeds received in connection with the issuance of Senior
  stock and warrants........................................  $40,000
Expenses incurred in connection with issuance...............     (365)
Fair value ascribed to warrants at issuance.................   (3,416)
                                                              -------
          Fair value of senior stock at date of issuance....   36,219
Accretion to Senior stock liquidation value.................       28
Accretion of Senior stock dividends.........................      488
                                                              -------
December 31, 1998 Senior stock carrying value...............   36,735
Accretion to Senior stock liquidation value.................      341
Accretion of Senior stock dividends.........................    4,990
                                                              -------
December 31, 1999, Senior stock carrying value..............   42,066
                                                              -------
Accretion to Senior stock liquidation value.................      341
Accretion of Senior stock dividends.........................    5,622
                                                              -------
December 31, 2000, Senior stock carrying value..............  $48,029
                                                              =======
</TABLE>

     Cumulative unpaid dividends on Senior stock are payable upon certain
defined events which include: the dissolution, liquidation or winding up of the
Company; the redemption of such shares; or the sale of substantially all of the
assets of the Company.

     Preferred Stock

     The Preferred Stock has liquidation preferences over Common Stock. The
Company's Series A and Series B stock have no conversion features or voting
rights except as required by law, and rank "pari passu."

     Series A stock has a liquidation value of $100 per share plus cumulative
unpaid dividends of $11,216 as of December 31, 2000. Series A stockholders are
entitled to a cumulative 14% annual dividend based upon the per share price of
$100.

                                       F-15
<PAGE>   50
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Series B stock has a liquidation value of $35 per share plus cumulative
unpaid dividends of $98 as of December 31, 2000. Series B stockholders are
entitled to a cumulative 14% annual dividend based upon the per share price of
$35.

     Cumulative unpaid dividends on all Preferred Stock are payable upon certain
defined events which include: the dissolution, liquidation or winding up of the
Company; the redemption of such shares; or the sale of substantially all of the
assets of the Company.

     Common Stock

     Class A stock and Class B stock each have identical terms with the
exception that Class A stock is entitled to one vote per share, while Class B
stock has no voting rights, except as required by law. In addition, Class B
stock is convertible into an equal number of Class A shares, at the option of
the holder of the majority of the Class B stock. To date, the Company has not
issued Class B stock.

  b. Stock Options and Warrants

     The following table summarizes the stock option activity for the year ended
May 31, 1998 the seven months ended December 31, 1998, and the years ended
December 31, 1999 and 2000:

<TABLE>
<CAPTION>
                                                        WEIGHTED                  WEIGHTED
                                                        AVERAGE                   AVERAGE
                                           CLASS A      EXERCISE     SERIES B     EXERCISE
                                           COMMON        PRICE       PREFERRED     PRICE
                                           -------      --------     ---------    --------
<S>                                        <C>          <C>          <C>          <C>
Balance at June 1, 1997..................  57,142        $ 1.00       164,783      $10.00
  Granted, April 1998....................  14,700        $17.50(i)         --
                                           ------        ------       -------
Balance at May and
  December 31, 1998......................  71,842        $ 4.38       164,783      $10.00
     Granted.............................  12,600        $53.00(ii)        --
     Exercised...........................    (718)(iii)  $ 5.73        (1,093)(i)  $10.00
     Cancelled...........................  (2,162)       $21.49            --
                                           ------                     -------
Balance at December 31, 1999.............  81,562        $11.42       163,690      $10.00
  Granted................................  17,846        $75.00(ii)        --
  Exercised..............................  (4,035)       $ 3.42        (5,384)     $10.00
  Cancelled..............................  (2,291)       $14.58            --
                                           ------                     -------
Balance at December 31, 2000.............  93,082        $23.88       158,306      $10.00
                                           ======                     =======
</TABLE>

---------------
  (i) Option exercise price of these 14,700 options ("1998 Grants") was less
      than the estimated fair value of $60.50 based upon independent appraisal.

 (ii) Option exercise price is equal to market price on the grant date based
      upon independent appraisal.

(iii) The Company repurchased 655 shares of common stock and 1,093 shares of
      Series B Preferred stock related to these exercises.

     All Series B Redeemable Preferred stock options were exercisable upon
grant. As of May 31, 1998, December 31, 1998, 1999 and 2000, a total of 25,797,
25,797, 49,511 and 68,279 Class A Common stock options were exercisable,
respectively.

                                       F-16
<PAGE>   51
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The following table summarizes stock option information as of December 31,
2000:

<TABLE>
<CAPTION>
                                     OPTIONS OUTSTANDING
                           ---------------------------------------      OPTIONS EXERCISABLE
                                           WEIGHTED-                  ------------------------
                                            AVERAGE      WEIGHTED-                   WEIGHTED-
                                           REMAINING      AVERAGE                     AVERAGE
                             NUMBER       CONTRACTUAL    EXERCISE       NUMBER       EXERCISE
                           OUTSTANDING       LIFE          PRICE      EXERCISABLE      PRICE
                           -----------    -----------    ---------    -----------    ---------
<S>                        <C>            <C>            <C>          <C>            <C>
Class A Common:
  1997 Grants............     50,936       72 months      $ 1.00         50,936       $ 1.00
  1998 Grants............     12,800       88 months      $17.50          9,174       $17.50
  1999 Grants............     11,500       96 months      $53.00          4,600       $53.00
  2000 Grants............     17,846      108 months      $75.00          3,569       $75.00
                             -------                                    -------
Total Grants.............     93,082                                     68,279
                             =======                                    =======
Series B Preferred.......    158,306      251 months      $10.00        158,306       $10.00
                             -------                                    -------
</TABLE>

     Class A Common Stock Options

     During the year ended May 31, 1997 the Company adopted the Town Sports
International Inc. Common Stock Option Plan (the "Plan"). The provisions of the
Plan, as amended and restated, provide for the Company's Board of Directors to
grant to executives and key employees options to acquire 94,092 shares of Class
A stock.

     The 1997 grants have a term of 10 years and originally vested based on the
achievement of annual equity values as defined. During the year ended May 31,
1998, the 1997 grants were amended (the "Amended Grants"). The amendment
impacted 45,714 options, which had not previously vested by adding a provision
whereby unvested outstanding options would automatically vest on December 10,
2005

     The 1998, 1999, and 2000 grants vest in full in December 2005, 2007 and
2008 respectively. The vesting of these grants will be accelerated in the event
that certain defined events occur including the achievement of annual equity
values or the sale of the Company. The term of each of these grants is 10 years.

     In accordance with APB No. 25, Accounting for Stock Issued to Employees,
the Company recorded unearned compensation in connection with the Amended Grants
and the 1998 Grants. Such amount is included within stockholders' deficit and
represented the difference between the estimated fair value of the Class A stock
on the date of amendment or grant, respectively, and the exercise price.
Unearned compensation will be amortized as compensation expense over the vesting
period. During the years ended May 31, 1998 and December 31, 1999 and 2000,
amortization of unearned compensation totaled $806, $1,258 and $969,
respectively. For the seven months ended December 31, 1998, no additional
options vested and accordingly there was no amortization of unearned
compensation.

     As of December 31, 2000, there were 1,010 shares reserved for future option
awards.

     Series B Preferred Stock Options

     During the year ended May 31, 1997, the Company granted 164,783 options
("Series B Options") to certain employees which entitle the holders to purchase
an equal number of shares of Series B stock at an exercise price of $10.00 per
share. Series B Options were fully vested on the date of grant and expire on
December 31, 2021. The terms of the Series B Options also contain provisions
whereby the exercise price will be reduced, or in certain cases, the option
holder will receive cash in accordance with a formula as defined. The aggregate
value of, either a reduction in exercise price, or the distribution of cash is
deemed compensatory and accordingly is recorded as a compensation expense. For
the year ended May 31, 1998, the seven months

                                       F-17
<PAGE>   52
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ended December 31, 1998, and the years ended December 31, 1999 and 2000
compensation expense recognized in connection with Series B Options totaled
$636, $434, $784 and $867, respectively. There are no shares of Series B
Preferred Stock reserved for future option grants.

     Pro Forma Operating Results

     The following table summarizes the pro forma operating results of the
Company had compensation costs for the outstanding options been determined in
accordance with the fair value based method of accounting for stock-based
compensation.

     Since option grants vest over several years and additional grants are
expected in the future, the pro forma results noted below are not likely to be
representative of the effects on future years of the application of the fair
value based method. No additional options vested during the seven months ended
December 31, 1998, therefore the effects of the fair value based method on
operating results for that period was immaterial.

<TABLE>
<CAPTION>
                                                                         YEAR ENDED
                                                       YEAR ENDED       DECEMBER 31,
                                                        MAY 31,      ------------------
                                                          1998        1999       2000
                                                       ----------    -------    -------
<S>                                                    <C>           <C>        <C>
Pro forma amounts:
  Net loss to common stockholders....................   $(1,804)     $(7,723)   $(3,950)
                                                        -------      -------    -------
</TABLE>

     For the purposes of the above pro forma information, the fair value of each
option granted was estimated on the date of grant using the Black-Scholes option
pricing model. For the year ending May 31, 1998, and the years ended December
31, 1999 and 2000, the weighted-average fair value of the option grants was
approximately $44.00, $30.10 and $47.11 respectively. The following
weighted-average assumptions were used in computing the fair value of options
grants: expected volatility of 60% for the years ended May 31, 1998 and December
31, 1999 and 69% for the year ended December 31, 2000, risk-free interest rate
of approximately 5.5%, 5.7% and 6.59% for May 31, 1998, and December 31, 1999
and 2000, respectively, expected lives of five years for December 31, 1999 and
2000, and three to five years for May 31, 1998; and a zero dividend yield for
all periods.

     Warrants to buy Common Stock

     In connection with the issuance of the Subordinated note payable on
December 10, 1996, warrants to buy 124,022 Class A Common Shares were issued at
an exercise price of $0.01 per share. Original issue discount arising upon this
issue, totaled approximately $123. 10,000 warrants were exercised on December
10, 1996. The amount of warrants outstanding was reduced during the seven months
ended December 31, 1998 by 38,308 to 75,714 in connection with the issuance of
the Senior stock. As of December 31, 2000, the remaining outstanding warrants
are fully exercisable and expire in December 2006.

                                       F-18
<PAGE>   53
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. ASSET ACQUISITIONS

     During the period from June 1, 1997 through December 31, 2000, the Company
completed the acquisition of 49 fitness clubs. With the exception of the
Ultrafit, Inc. and Affiliates ("Ovox"), Lifestyle Fitness of Springfield, Inc.
and Affiliates ("Lifestyle") and Health Development Corporation ("HDC")
acquisitions, as discussed below, the individual acquisitions were not material
to the financial position or results of operations or cash flows of the Company.
The table below summarizes the aggregate purchase price and the purchase price
allocation to assets acquired:

<TABLE>
<CAPTION>
                                                                SEVEN MONTHS       YEARS ENDED
                                                  YEAR ENDED       ENDED          DECEMBER 31,
                                                   MAY 31,      DECEMBER 31,    -----------------
                                                     1998           1998         1999      2000
                                                  ----------    ------------    ------    -------
<S>                                               <C>           <C>             <C>       <C>
Number of clubs acquired........................        16             16            4         13
                                                   =======        =======       ======    =======
Purchase prices payable in cash at closing......   $19,733        $25,103       $2,932    $24,053
Issuance and assumption of notes payable........     4,110          4,654        1,476      2,238
                                                   -------        -------       ------    -------
          Total purchase prices.................   $23,843        $29,757       $4,408    $26,291
                                                   =======        =======       ======    =======
Allocation of purchase prices:
  Goodwill......................................   $11,157        $17,871       $2,318    $19,926
  Fixed assets..................................     9,011          9,177          986      6,809
  Membership lists..............................     2,978          2,559          427      3,548
  Covenants-not-to-compete......................       400            150          701         25
  Other net assets (liabilities) acquired.......       297                         (24)      (372)
     Deferred revenue...........................                                           (3,645)
                                                   -------        -------       ------    -------
          Total allocation of purchase prices...   $12,686        $11,886       $2,090    $ 6,365
                                                   =======        =======       ======    =======
</TABLE>

     For financial reporting purposes, these acquisitions have been accounted
for under the purchase method and, accordingly, the purchase prices have been
assigned to the assets and liabilities acquired on the basis of their respective
fair values on the date of acquisition. The excess of purchase prices over the
net tangible assets acquired has been allocated to membership lists acquired,
covenant-not-to compete and goodwill. The results of operations of the clubs
have been included in the Company's consolidated financial statements from the
respective dates of acquisition and the impact of these acquisitions on the
consolidated financial statements of the Company was not material, with the
exception of the following acquisitions:

     In April 1998, the Company acquired Ovox. Ovox's operations consisted of
four clubs in New Jersey which were owned and operated by a common group of
investors. The purchase price totaled $8,177, which included $7,750 of cash and
notes payable of $236. Transaction costs amounted to $191. The excess of the
purchase price over the net fair value of the assets acquired was $6,589, and
has been allocated to the membership lists acquired and goodwill. The following
unaudited pro forma information has been prepared assuming the Ovox acquisition
had taken place at the beginning of the period shown. The pro forma adjustments
give effect to amortization of goodwill, interest expense on acquisition debt,
and related income tax effects:

<TABLE>
<CAPTION>
                                                              FOR THE YEAR
                                                                 ENDED
                                                                MAY 31,
                                                                  1998
                                                              ------------
                                                              (UNAUDITED)
<S>                                                           <C>
Revenues....................................................    $87,158
Pro forma net income before extraordinary items and
  cumulative effect of change in accounting policy..........      1,127
Proforma net loss to common stockholders....................    $(2,130)
</TABLE>

                                       F-19
<PAGE>   54
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In August 1998 the Company acquired Lifestyle. Lifestyle's operations
consisted of six clubs in New Jersey, which were owned and operated by a common
group of investors. The purchase price totaled $10,752, which included $10,000
of cash and notes payable of $300. Transaction costs amounted to $452. The
following unaudited pro forma information has been prepared assuming the
Lifestyle Acquisition had taken place at the beginning of the respective
periods. The pro forma adjustments give effect to amortization of goodwill,
interest expense on acquisition debt, and the related income tax effects:

<TABLE>
<CAPTION>
                                                                             FOR THE SEVEN
                                                             FOR THE YEAR       MONTHS
                                                                ENDED            ENDED
                                                               MAY 31,       DECEMBER 31,
                                                                 1998            1998
                                                             ------------    -------------
                                                             (UNAUDITED)      (UNAUDITED)
<S>                                                          <C>             <C>
Revenues...................................................    $90,037          $72,989
Pro forma net income (loss) before extraordinary items and
  cumulative effect of change in accounting policy.........      1,130             (644)
Proforma net loss to common stockholders...................    $(2,128)         $(2,790)
</TABLE>

     In July, 2000, the Company acquired Health Development Corporation ("HDC")
a Massachusetts Corporation. HDC's operations included eight clubs in
Massachusetts and one club in New Hampshire. HDC also provided management
services at three facilities in the greater Boston area. HDC was purchased for
$18,700 in cash. Including approximately $525 of transaction costs the aggregate
purchase price amounts to $19,200. The acquisition was financed with $6,000 of
borrowings under the line of credit, and cash on hand.

     The following unaudited pro forma information has been prepared assuming
the HDC acquisition had taken place at the beginning of the respective periods
reported herein. The pro forma adjustments give effect to amortization of
goodwill, amortization of membership lists, interest expense on acquisition
debt, adjustments to rent expense and the related income tax effects.
Immediately prior to the acquisition HDC sold the land and buildings related to
two of its fitness clubs and entered into leases with the new landlords of these
clubs. Rent expense, interest on mortgages and building depreciation related to
these two clubs have also been adjusted.

<TABLE>
<CAPTION>
                                                                 FOR THE YEARS ENDED
                                                                     DECEMBER 31,
                                                              --------------------------
                                                                 1999           2000
                                                              -----------    -----------
                                                              (UNAUDITED)    (UNAUDITED)
<S>                                                           <C>            <C>
Pro forma revenues..........................................   $175,981       $234,771
Pro forma net income (loss).................................   $ (1,149)      $  4,179
Pro forma net loss to common shareholders...................   $ (9,029)      $ (4,837)
</TABLE>

     The unaudited pro forma financial information for Ovox, Lifestyle and HDC
is presented for information purposes only and may not be indicative of the
results of operations as they would have been had the Company completed the
acquisitions as of and for the periods noted above, nor is it indicative of the
results of operations which may occur in the future. Anticipated efficiencies
from the consolidation of Ovox, Lifestyle and HDC and the Company have been
excluded from the amounts included in the pro forma summaries presented above.

                                       F-20
<PAGE>   55
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. REVENUE FROM CLUB OPERATIONS

     Revenues from club operations for the years ended May 31, 1998, the seven
months ended December 31, 1998 and the years ended December 31, 1999 and 2000
are summarized below:

<TABLE>
<CAPTION>
                                                     SEVEN MONTHS        YEARS ENDED
                                       YEAR ENDED       ENDED            DECEMBER 31,
                                        MAY 31,      DECEMBER 31,    --------------------
                                          1998           1998          1999        2000
                                       ----------    ------------    --------    --------
<S>                                    <C>           <C>             <C>         <C>
Membership dues......................   $66,878        $59,105       $132,467    $182,368
Initiation Fees......................     4,408          3,374          7,635      11,033
Other club revenues..................     8,433          7,485         17,338      29,023
                                        -------        -------       --------    --------
                                        $79,719        $69,964       $157,440    $222,424
                                        =======        =======       ========    ========
</TABLE>

12. CORPORATE INCOME TAXES

     The provision (benefit) for income taxes for the year ended May 31, 1998,
the seven months ended December 31, 1998 and the years ended December 31, 1999
and 2000 consists of the following:

<TABLE>
<CAPTION>
                                                                   YEAR ENDED
                                                                  MAY 31, 1998
                                                         -------------------------------
                                                                      STATE
                                                         FEDERAL    AND LOCAL     TOTAL
                                                         -------    ---------    -------
<S>                                                      <C>        <C>          <C>
Current................................................  $1,383       $ 935      $ 2,318
Deferred...............................................    (751)       (436)      (1,187)
                                                         ------       -----      -------
                                                         $  632       $ 499      $ 1,131
                                                         ======       =====      =======
</TABLE>

<TABLE>
<CAPTION>
                                                               SEVEN MONTHS ENDED
                                                                DECEMBER 31, 1998
                                                         -------------------------------
                                                                      STATE
                                                         FEDERAL    AND LOCAL     TOTAL
                                                         -------    ---------    -------
<S>                                                      <C>        <C>          <C>
Current................................................   $ 588       $ 425      $ 1,013
Deferred...............................................    (952)       (460)      (1,412)
                                                          -----       -----      -------
                                                          $(364)      $ (35)     $  (399)
                                                          =====       =====      =======
</TABLE>

<TABLE>
<CAPTION>
                                                                  YEAR ENDED
                                                               DECEMBER 31, 1999
                                                        -------------------------------
                                                                     STATE
                                                        FEDERAL    AND LOCAL     TOTAL
                                                        -------    ---------    -------
<S>                                                     <C>        <C>          <C>
Current...............................................  $ 2,432     $ 1,398     $ 3,830
Deferred..............................................   (1,932)     (1,327)     (3,259)
                                                        -------     -------     -------
                                                        $   500     $    71     $   571
                                                        =======     =======     =======
</TABLE>

<TABLE>
<CAPTION>
                                                                  YEAR ENDED
                                                               DECEMBER 31, 2000
                                                        -------------------------------
                                                                     STATE
                                                        FEDERAL    AND LOCAL     TOTAL
                                                        -------    ---------    -------
<S>                                                     <C>        <C>          <C>
Current...............................................  $ 5,679     $2,446      $ 8,125
Deferred..............................................   (3,170)      (156)      (3,326)
                                                        -------     ------      -------
                                                        $ 2,509     $2,290      $ 4,799
                                                        =======     ======      =======
</TABLE>

                                       F-21
<PAGE>   56
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The components of the net deferred tax asset as of, December 31, 1999 and
2000 are summarized below:

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1999       2000
                                                              -------    -------
<S>                                                           <C>        <C>
Deferred tax assets:
  Deferred lease liabilities................................  $ 5,927    $ 7,287
  Deferred revenue..........................................    4,487      5,783
  Fixed assets and intangible assets........................    2,291      4,161
  Compensation expense incurred in connection with stock
     options................................................    3,335      4,073
  State net operating loss carry-forwards...................      646        446
  Other.....................................................      154         47
                                                              -------    -------
                                                               16,840     21,797
                                                              -------    -------
Deferred tax liabilities:
  Deferred costs............................................   (4,662)    (6,027)
  Acquired membership liabilities...........................                (770)
  Accrued expenses..........................................      (65)      (150)
                                                              -------    -------
                                                               (4,727)    (6,947)
                                                              -------    -------
     Net deferred tax assets, prior to valuation
       allowance............................................   12,113     14,850
Valuation allowance.........................................     (284)      (284)
                                                              -------    -------
     Net deferred tax assets................................  $11,829    $14,566
                                                              =======    =======
</TABLE>

     As of December 31, 2000, the Company has state net operating loss ("Nol")
carry-forwards of approximately $4,833. Such amounts expire between December 31,
2001 and December 31, 2009. For the seven months ended December 31, 1998 the
Company increased the valuation allowance from $184 to $284. The Company's $284
valuation allowance has been maintained for Nol carryforwards in states which
are not generating taxable income.

     Foreign income and the effect of foreign income taxes was immaterial.

     The following table accounts for the differences between the actual
provision and the amounts obtained by applying the statutory U.S. Federal income
tax rate of 34% and 35% in 2000 to the income (loss) before provision (benefit)
for corporate income taxes:

<TABLE>
<CAPTION>
                                                             SEVEN MONTHS    YEARS ENDED
                                               YEAR ENDED       ENDED        DECEMBER 31,
                                                MAY 31,      DECEMBER 31,    ------------
                                                  1998           1998        1999    2000
                                               ----------    ------------    ----    ----
<S>                                            <C>           <C>             <C>     <C>
Federal statutory tax rate...................      34%           (34)%        34%     35%
State and local income taxes, net of federal
  tax benefit and change of valuation
  allowance..................................      15            (13)          8       8
Change in state effective income tax rate....      --             14          40       3
Non-deductible goodwill and other permanent
  differences................................      --             --          10       5
Non-taxable interest income..................      --            (11)         --      --
Other........................................       1              2          --      (1)
                                                   --            ---          --      --
                                                   50%           (42)%        92%     50%
                                                   ==            ===          ==      ==
</TABLE>

                                       F-22
<PAGE>   57
                TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. CONTINGENCIES

     The Company is a party to various lawsuits arising in the normal course of
business. Management believes that the ultimate outcome of these matters will
not have a material effect on the Company's consolidated financial position,
results of operations or cash flows.

14. EMPLOYEE BENEFIT PLAN

     The Company maintains a 401(k) defined contribution plan and is subject to
the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA").
The Plan provides for the Company to make discretionary contributions; however,
the Company elected not to make contributions for the year ended May 31, 1998,
the seven months ended December 31, 1998, and the years ended December 31, 1999
and 2000. The Plan was amended, effective January 1, 2001, to provide for an
employer matching contribution in an amount equal to 25% of the participant's
contribution with a limit of five hundred dollars per annum.

15. EXTRAORDINARY ITEM

     During the year ended May 31, 1998, the Company completed a $85,000
financing. As part of this financing, an existing term loan, a line of credit
and a subordinated note were repaid. Accordingly, previously capitalized fees
and expenses relating to obtaining such financing of $1,406 were written off,
net of taxes of $624.

                                       F-23